Having said that, if you think that markets are magically the solution to everything and have some kind of mystical inherent ability to always be right and to self-regulate in all conditions, all weathers, all extremities, and despite all unforeseen circumstances, well then, you are probably a neoliberal economist.
This received wisdom about the superiority of the neoliberal model was destroyed by the recent credit crunch. One of the dogmas of this school is the idea that markets can solve any problem that markets create. What happened in the credit crunch was a flat contradiction of that dogma: markets created a problem that needed financial intervention from states on a historically unprecedented scale. This poses a problem for neoliberalism, and not just because of its faith in the idea that markets can self-regulate. Contained within the idea of self-regulation is the notion that markets are efficient.

…

During the daily process, each bank is asked the rate at which it could borrow money from other banks, “unsecured,” in other words backed only by its own creditworthiness rather than by specific collateral. The banks are asked, in effect, what would your credit be like today, if you had to ask? During the credit crunch, the if aspect of Libor became overpoweringly apparent, since the salient fact about the interbank market was that banks were refusing to lend money to each other. That, in essence, was what the credit crunch was—banks being too scared to lend to each other. In the very dry words of Mervyn King, the then governor of the Bank of England, Libor became “in many ways the rate at which banks do not lend to each other.” Euribor, the euro version of Libor, is at the moment even worse, since in very many cases these banks would be more likely to voluntarily turn themselves into lap-dancing clubs rather than make unsecured loans to each other.

…

Bailing out the banks, for instance, creates a classic form of moral hazard, because it exempts those banks from the consequences of their mistakes. Perhaps the most spectacular example during the credit crunch was the bailout/nationalization of AIG, the company that had insured most of the world’s credit default swaps, and as a result was on the brink of going broke. Banks had taken out insurance with AIG, and there was a case to be made for punishing them for being so stupid. Instead AIG got its bailout, which mainly involved direct transfers of cash to the banks that were its counterparties. The banks suffered no consequences for their mistakes, and so had no incentives to avoid such mistakes in the future—a textbook example of moral hazard. It was worry about moral hazard that made the Bank of England slow to act when the first signs of the credit crunch appeared with the collapse of the bank Northern Rock in autumn 2007.

So David Simon and his colleagues made a five-part, sixty-episode work of art—in effect a huge televised novel, which, as many observers have remarked, is Balzacian in its scope and achievement—and still managed to miss out on one of the worst disasters to affect Baltimoreans in decades. The credit crunch has cost 33,000 householders in Baltimore their properties, victims of the wave of mortgage foreclosures. This in a city where the population has in recent decades fallen from around a million to about 300,000 less, and where 50,000 homes were already lying unoccupied. As you drive around past block after block of abandoned properties, boarded up, some of them mere shells, some of them—some of the saddest—leaving one or two occupied houses behind in their wake, clinging bravely or desperately to what used once to be a decent place to live—it’s hard not to think that this city looks as if it lost a war. It looked like that already before the credit crunch, but this city needed 33,000 home repossessions about as much as London needed the Luftwaffe during the Second World War.

…

He turned down the opportunity to participate in Madoff’s fund, a decision which cost him a good deal of political capital at his bank, until Madoff was exposed as a fraudster (and the banker who turned him down was promoted). Why did he turn down Madoff? “Because it just didn’t smell right.”
Funny smells come in a variety of types. The funny smells surrounding the credit crunch were not for the most part to do with fraud—though having said that, a CDO investor who had had a long look at the way mortgages were being originated would have been gagging on fraud-related stench. Mainly, they were funny smells to do with things which were just too good to be true. That is a critically important category of funny smells, and it is the kind which is most relevant in the story of the credit crunch. It is a category of funny smell which involves an element of the willful, or of wishful thinking; or perhaps just of ignoring what’s in front of your nose. To adopt a metaphor I heard used by the chancellor of the Exchequer, Alistair Darling, it’s a bit like putting flowers in the hallway as a solution to the problem of dry rot.

…

There needs to be a general acceptance that the model has failed: the brakes-off, deregulate or die, privatize or stagnate, lunch is for wimps, greed is good, what’s good for the financial sector is good for the economy model; the “sack the bottom 10 percent,” bonusdriven, “if you can’t measure it, it isn’t real” model; the model which spread from the City to government and from there through the whole culture, in which the idea of value has gradually faded to be replaced by the idea of price.
When the credit crunch first began—after the initial waves of panic and the moment when “this sucker could go down”—I thought that there might be a general reevaluation of where we all were. We wouldn’t notice and reflect just on the past decade of good times but on the whole question of what our societies had as their goals, where capitalism had brought us, and whether we wanted to keep working quite as hard as we had, in the direction of an always-receding vision of contentment. The “hedonic treadmill” is what this is called: as you have more and more, your idea of what it would take to be happy keeps receding just out of reach. It’s always the next pay raise, the next purchase, the next place you move to or go on holiday which will make you happy. The credit crunch could have been a moment to reflect on that.

Richard Koo’s thinking is informed by his close analysis of Japan’s credit crunch and post-credit crunch recession. He observes that Japanese firms in the 1990s and early 2000s changed their behaviour dramatically. They were no longer profit maximisers but debt minimisers. Between 1970 and the early 1990s, during the long ‘yang’ (sun or light) economic upswing, Japanese companies had steadily built up their debts to finance investment and growth. But from the early 1990s onwards they used every spare yen to pay off their debts. Even as interest rates fell to zero and firms were presented with numerous opportunities for growth, they still insisted on paying off their debts rather than investing in the future. The collapse in property prices that followed the credit crunch had traumatised them, because it meant that the value of their assets no longer matched their liabilities.

…

The Treasury has also provided some illustrative examples of the scale of the cumulative loss in wealth that today’s crisis has exposed, and it points to similar cumulative losses of output.2 Economic growth needs to accelerate to 3.25 per cent in the decades ahead – which would be a heroic achievement, given the structure of the economy and the rebalancing that must take place – in order for national output to reach its predicted level had the credit crunch and the recession not taken place. Even if that proves possible, full recovery will not be achieved before 2031. If the gap between where Britain thought it was going to be and where it actually will be is added up year by year from now until 2031, the total loss of output because of the crisis will be £2.3 trillion. But there is a more plausible scenario. If growth remains at 2.75 per cent (its average level in the years leading up to the credit crunch), then it might never recover sufficiently to converge with the old trajectory. In that case the cumulative loss of output would be over £4 trillion and would keep rising for ever.

…

The institute cites Japan as a warning of what might happen – as does Richard Koo, chief economist of Japan’s Nomura Research Institute.7 For more than a decade of his professional life, Koo has been exploring the fallout of Japan’s 1989–92 credit crunch on the $5 trillion Japanese economy. His prognosis is alarming, and confirms the McKinsey analysis: the Americans, the British and especially the mainland Europeans are far too complacent, Koo thinks. We do not recognise the sea-change in the behaviour of firms and economies after asset price bubbles, credit crunches and subsequent attempts to reduce leverage. The consensus expectation of a return to business as usual, albeit at lower growth rates, is at the optimistic end of what will happen. This is at the heart of the debate about the timing and depth of what economists euphemistically call ‘fiscal consolidation’ – that is, budget deficit cutting.

And as this new story about the nature of Wall Street and its products replaced the old story, the life drained out of the financial markets. The demand for the exotic products collapsed, and the credit crunch began.
The credit crunch began for three separate reasons. First, and most obviously, a standard mode of financing had collapsed. Those who originated loans (mortgages, for instance) could no longer expect to be able to package them and pass them on easily to unsuspecting third parties. Now if they were going to originate those loans either they would have to keep them ultra-safe before they passed them on, or they would have to keep them themselves.5
The second reason for the credit crunch involves the relation between capital loss and leverage. Many of the institutions that held the loans or that originated them—depository banks, investment banks, and bank holding companies—had themselves invested in the new financial products.

…

The idea of targeting credit goes at least as far back as an article written by current Fed Chair Ben Bernanke and former Fed Vice-Chair Alan Blinder in 1988.8 (It should not be confused with economists’ discussions of targeting monetary policy, mainly by targeting the rate of inflation.9 That literature does not concern itself with how to countervail a credit crunch.)
Achieving the credit target is urgent for several reasons. Most notably, firms that count on outside finance will go bankrupt if they cannot obtain credit. If the credit crunch continues and many firms go bankrupt, it would take an impossibly large fiscal and monetary policy stimulus to achieve full employment.
There is the further problem that, as long as credit markets are frozen, the need for fiscal and monetary stimulation will continue. Using the appropriate fiscal and monetary stimulus, in sufficient amount, could possibly keep us at full employment. But to do so without relieving the credit crunch would be like propping a sick man up in bed so that he looks all right. He will collapse again just as soon as you remove the prop.

…

In the postscript to Chapter 7 we recommend that, in addressing the current crisis, the government have two targets. The first such target— and the only one that would be needed in a normal recession—would be a monetary policy and a fiscal policy that would be jointly sufficient to return the economy to full employment. But because of the severe credit crunch, which has been induced by the low state of confidence, such a stimulus is not enough. Indeed, in the face of the credit crunch, it might take very large increases in government expenditures or tax reductions to reach full employment. So we argue that government macroeconomic policy should have a second, intermediate target. Credit flows should also be targeted at the level that would normally prevail at full employment. In the postscript to Chapter 7 we shall describe how the Federal Reserve has developed clever schemes that could enable it to achieve such a target even in these dire times.

Moreover, because unconventional policies lower the cost of government borrowing – they operate partly through central-bank purchases of either government or quasi-government debt, thereby increasing the supply of money – there is no great pressure on the US government to put its fiscal house in order. If the long-term costs of the credit crunch are persistently high budget deficits funded through resort to the printing press, holders of dollars elsewhere in the world have every right to be very worried indeed.
US PROBLEMS AND SIXTEENTH-CENTURY SPAIN
The US response to the credit crunch may be the last throw of the dice for a country that, for too long, has been able to live beyond its means. To understand what’s at stake, it’s worth going all the way back to the sixteenth century when, for a while, Spain was, like the US today, an all-conquering nation.

…

In practice, however, these cross-border capital flows are sometimes a source of inefficiency given that many of the biggest players are nation states that choose not to pursue commercial objectives but, instead, focus on meeting the interests of their various internal constituents: the US government is the world’s biggest borrower while the Chinese, Saudis and Russians are among the world’s biggest savers.
It may be that the data simply do not exist to measure, calibrate and analyse these growing interactions between the developed and emerging worlds, but that does not mean to say they can be ignored. Regrettably, as with the 2007/8 credit crunch, they too often are. Even when they are taken into account, it’s often just one-way traffic. Plenty of economists spend their time trying to work out how developments in the United States affect the rest of the world. Few spend their time asking how the rest of the world and, in particular, the emerging nations affect the US. Yet, as I argue in this book, this second question needs to be asked more and more if we are to understand anything about developments in the world economy and in our own economies in the twenty-first century.

…

History, politics and geography matter. Too often, economists end up lost in a mathematical world of esoteric equations which cannot provide answers to the really big questions affecting society. At the British Academy in the summer of 2009, the great and the good of the UK economics profession met to discuss the drafting of a letter to Her Majesty the Queen intended to explain why economists had failed to spot the credit crunch. The letter subsequently delivered to Buckingham Palace ended as follows:
In summary, Your Majesty, the failure to foresee the timing, extent and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.
A simpler conclusion might have been to say that many bright people had failed to learn the lessons of history, politics and geography.

Having tried, with this historical digression, to convince the reader that describing former senior bankers as financially incompetent is not, ipso facto, an oxymoron, I can return to the narrative of more recent events.
In the summer of 2008, the life-threatening phase of the credit crunch appeared to be ending. U.S. growth in the second quarter had just been revised upwards from 1.2 percent to 1.8 percent13 and the biggest worry was no longer the credit crunch but the threat of inflation caused by overly rapid growth in China, India, and other emerging nations.
The credit crunch was turning out to be less damaging than generally expected for several reasons. One was the continuing growth of Asia and the seemingly inexhaustible supply of excess savings in that part of the world. These savings were made available by the Sovereign Wealth Funds (SWFs) of Abu Dhabi, Singapore, Korea, China, and other countries to Western financial institutions that needed to rebuild their capital after their initial subprime losses—which helped maintain financial stability throughout the first twelve months of the subprime crisis.

…

O’Rourke
THE COLLAPSE OF LEHMAN on September 15, 2008, was the financial heart attack that turned a serious but manageable ailment in the U.S. mortgage market into a near-death experience for the global economy.1 Even before that fateful day, many banks and borrowers were in serious trouble, but the situation seemed to be improving and certainly not spinning out of control. The credit crunch that had begun in early 2007 could still be viewed as a severe but fairly normal cyclical correction, reversing some excesses in bank lending and property speculation that the world had seen many times before. The world economy was showing surprising resilience, and policymakers and investors worldwide suggested by their behavior that they genuinely believed the worst was over. Economic growth was still positive. House prices were stabilizing. Consumer and business confidence were recovering, as the price of oil fell back from the peak of $150 a barrel that it hit in response to speculative fears of excessive growth in China and other emerging economies. The biggest worry on the minds of most economists and businesspeople that summer was no longer the credit crunch but the threat of inflation caused by the earlier surge in the oil prices.

…

But if a single link in the debt-chains between financial institutions were broken, chaos would ensue. The risk of such breakdowns had been recognized by both regulators and bankers in the early days of the credit crunch and had been successfully handled (albeit at huge cost to bank shareholders) in 2007, when the mortgage-oriented hedge funds and Special Investment Vehicles set up by Bear Stearns, Citibank, UBS, HSBC, and many other major banks were bailed out by their sponsoring institutions. These bailouts were expensive to the bank shareholders but prevented systemic collapse by maintaining the integrity of all the links in the chain of mutual obligations in the financial system. This was a crucial lesson of the early phase of the credit crunch that the U.S. Treasury and the Fed recognized in the Bear Stearns deal but, in the autumn of 2008, decided to recklessly ignore.

The average Wall Street bonus in 2009—at the very height of the crisis—was close to
its highest in history. Forbes counted a record number of 1210 billionaires in 2011, up
by 28 per cent over 2007. Their combined wealth has risen from $3,500 billion in
2007 to $4,500 billion in 2010. Little more than a thousand individuals commanded a
sum equivalent to a third of the output of the American economy.
In the UK, the City bonus pool in 2010 came close to pre-credit crunch levels. The
average pay of the chief executives of Britain’s largest 100 companies rose by 55 per
cent in the first six months of 2010 to stand at almost £5 million. Big business is
enjoying surging profit levels, with many of the nation’s largest conglomerates sitting
on near-record levels of cash, most of it standing idle.
In contrast to the rising fortunes at the top, living standards for most Britons,
Americans and Europeans are on a downward slide.

…

Some of these have done much better than
others—especially those working in well paid white collar professions outside of the
corporate and City super-elite—such as lawyers, accountants and medics. But most
have ended up in the slow lane of earnings growth, with earnings that have fallen way
behind the growth of the economy.73
While incomes continued to rise sharply amongst the very top income groups in the
decade before the credit crunch, real income growth amongst those lower down the
income scale started to slow and at an accelerating rate. During Labour’s first term in
power, much of the workforce enjoyed faster rises in take-home pay than in the
previous 15 years. As a result, the wage share recovered some of its lost ground
between 1996 and 2001. But the party did not last for long. The ‘feast’ years of the
late 1990s gave way first to the ‘lean’ years of Labour’s second term and then the
‘famine’ years during its third.

…

In the three decades to 2008, the number of jobs in
manufacturing fell from just over 7 to just over 3 million.103
As shown in figure 3.2, by 2007, manufacturing in the UK accounted for nearly 13
per cent of national output, down from a third in 1979. The share of output accounted
for by finance, in contrast, doubled from around 5 per cent in the mid-1970s to slightly
over ten per cent by 2008.104
The expansion of finance accelerated from the second half of the 1990s. In the three
years to 2007—before the onset of the credit crunch—financial services accounted for
a third of overall GDP growth (another third came from residential and commercial
property) and had grown to play a bigger role in the economy than in any other
comparable nation.105 Thus financial services accounts for 7.5 per cent of the US
economy, 6.7 per cent in Japan, 4.6 per cent in France and 3.8 per cent in Germany.
As became clear in the turmoil of 2008-9, it is not good for resilience to have such a
heavily skewed pattern of economic activity.

Ending this depression should be, could be, almost incredibly easy.
So why aren’t we doing it? To answer that question, we have to look at some economic and, even more important, political history. First, however, let’s talk some more about the crisis of 2008, which plunged us into this depression.
CHAPTER THREE
THE MINSKY MOMENT
Once this massive credit crunch hit, it didn’t take long before we were in a recession. The recession, in turn, deepened the credit crunch as demand and employment fell, and credit losses of financial institutions surged. Indeed, we have been in the grips of precisely this adverse feedback loop for more than a year. A process of balance sheet deleveraging has spread to nearly every corner of the economy. Consumers are pulling back on purchases, especially on durable goods, to build their savings.

…

In January 2009, as the outlines of the plan became visible, sympathetic economists outside the administration were very publicly worried about what they feared would be the economic and political consequences of the half measures being contemplated; we know now that some economists inside the administration, including Christina Romer, the head of the Council of Economic Advisers, shared these sentiments.
To be fair to Obama, his failure was more or less paralleled throughout the advanced world, as policy makers everywhere fell short. Governments and central banks stepped in with cheap-money policies and enough aid to the banks to prevent a repeat of the wholesale breakdown of finance that took place in the early 1930s, creating a three-year credit crunch that played a major role in causing the Great Depression. (There was a similar credit crunch in 2008–09, but it was much shorter-lived, lasting only from September 2008 to the late spring of 2009.) But policies were never remotely strong enough to avoid a huge and persistent rise in unemployment. And when the initial round of policy responses fell short, governments across the advanced world, far from acknowledging the shortfall, treated it as a demonstration that nothing more could or should be done to create jobs.

…

And since both conventional and shadow banks are highly leveraged, it didn’t take a lot of losses on this scale to call the solvency of many institutions into question.
The seriousness of the situation began to sink in on August 9, 2007, when the French investment bank BNP Paribas told investors in two of its funds that they could no longer withdraw their money, because the markets in those assets had effectively shut down. A credit crunch began developing, as banks, worried about possible losses, became unwilling to lend to one another. The combined effects of the decline in home construction, weakening consumer spending as the fall in home prices took its toll, and this credit crunch pushed the U.S. economy into recession by the end of 2007.
At first, however, it wasn’t that steep a downturn, and as late as September 2008 it was possible to hope that the economic downturn wouldn’t be all that severe. In fact, there were many who argued that America wasn’t really in recession.

203;
Regulation 204; Protected rights 205; The future for SIPPs 205;
Postscript 206
177
Appendix: Contributors’ contact details
Index
Index of advertisers
183
191
199
207
212
214
private client
services
XII
Trusts, probate and tax planning
Residential property
purchases and sales
Relationships: formation and
breakdown and the consequences
Contact
Ian Lane, Partner
020 7293 4801
ilane@dac.co.uk
www.dac.co.uk/privateclient
XIII ឣ
Nil Rate Band Will Trusts: Are they still of value?
Way back in October 2007 in the time before the banking crisis, ‘the credit
crunch’, falling markets, massive job losses and recession (or is it
depression!) the UK Government made a surprise announcement of a
change to the inheritance tax legislation that was to have a profound
effect on tax planning using Wills. This was the announcement of the
introduction of the transferable Nil Rate Band. The announcement
followed very quickly on a statement by the Conservative Party that, if
elected, they were going to introduce a Nil Rate Band of £1m per person.

…

The work of IAAG is a competitive differentiator for Citi Private Bank,
contributing to its intellectual leadership and forming the cornerstone of investment
conversation with clients. Philip has been with Citi for eight years. His previous
assignments have included working for the Corporate and Investment Bank in
equity derivatives, where he performed diverse roles including senior profit and loss
analysis, risk management and warrants trading.
1
Introduction
In 2008 conventional private investor thinking was turned upside down following
the ‘credit crunch’ and the ensuing stream of dismal revelations of imprudent bank
lending, financial products based on the packaging of toxic debt and inadequate
financial sector regulation. Previous conceptions of what were safe forms of
investment and how diversified portfolios could be structured at acceptable levels of
risk were tossed aside. High-net-worth individuals (HNWs) and others with significant capital assets, including pension pots, available for investment have had to
rethink their investment strategies.

…

The final
chapter in this section of the book is an explanation of the new ‘user-friendly’
private foundation vehicle now available in Jersey.
Part Two addresses the disparate worlds of real estate and forestry. Tim Bowring
of Citi Private Bank team offers definitions of the various property-backed funding
alternatives and a frank analysis of the causes of the present market downturn that
generated the credit crunch. James Price of Knight Frank describes the current
condition of the overseas property market. In the two chapters that follow Alan Guy
and Alastair Sandels of Fountains identify current opportunities in forestry
investment and the risks of direct investment in forestry. In contrast, Guy Conroy of
Oxigen Investments advocates timber in South-East Asia as both a profitable and
ethical investment destination.

As the United States exports relatively little to China, the latter has enjoyed a large and rising trade surplus which has grown very rapidly since 1999.147 China has invested this surplus in various forms of US debt, including Treasury bonds, agency bonds and corporate bonds - in effect, a Chinese loan to the US - thereby enabling American interest rates to be kept artificially low to the benefit of American consumers and especially, until the credit crunch, holders of mortgages. Although the US was deeply in debt, China’s continuing large-scale purchase of Treasury bonds (which I will use as shorthand for various forms of US assets held by China) allowed Americans to continue with their spending spree, and then partially helped to cushion the impact of the credit crunch. In September 2008 China’s foreign currency reserves totalled $1.81 trillion - a sum greater than the annual economic output of all but nine countries.148 The rapid growth of its foreign exchange reserves has made China a colossus in the financial world.

…

In early 2007 the government announced the formation of the China Investment Corporation, a new state agency to oversee investment of $200 billion of China’s foreign currency reserves - similar to Temasek Holdings, the Singapore government’s successful investment agency, which manages a $108 billion global portfolio of investments.153 To test the water, the new agency placed $3 billion of its holdings with Blackstone, the US-based private equity group, thereby signalling Beijing’s intention to switch some of its investments from US Treasury bonds into more risky equity holdings.154 In fact it has since emerged that the State Administration of Foreign Exchange, which oversees China’s reserves, has itself been investing rather more widely than was previously believed.155 These moves herald China’s rise as a major global financial player.156 In the second half of 2007, as the credit crunch began to bite, China Development Bank took a significant stake in the UK-based Barclays Bank157 and Citic Securities formed a strategic alliance with the US investment bank Bear Stearns before the latter went bust.158 Three Chinese banks were also in talks about acquiring a stake in Standard Chartered, the UK-based emerging markets lender.159 But most of this came to nought as the Chinese increasingly realized the likely severity of the credit crunch and the potential threat it represented to any stakes in Western financial institutions that it might purchase. When the financial meltdown came in September 2008, the Chinese found themselves relatively little exposed.

…

The winners, above all the US corporate giants that have moved their manufacturing operations to China and the consumers who have benefited from China prices at home, still considerably outnumber the losers and in any case enjoy much greater power.143 But this could change. The political consequences of spiralling commodity prices, especially oil prices, which were brought to a premature end by the credit crunch, could, if they had continued, have turned American attitudes towards China in a more negative direction. More pertinently, the threat of a serious and prolonged depression is already leading to growing demands for protection.144 It is striking that, even before the credit crunch, the number of Americans who thought that trade with other countries was having a positive impact on the US fell sharply from 78 per cent in 2002 to only 59 per cent in 2007.145
In the longer term, as Chinese companies relentlessly climb the technology ladder, the US economy will face ever-widening competition from Chinese goods, no longer just at the low-value end, but also increasingly for high value-added products as well, just as happened earlier with Japanese and Korean firms.146 In that process, the proportion of losers is likely to increase rapidly, as will be the case in Europe too.

Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions is a highly accessible and authoritative book written by investment bankers that explains how to perform the valuation work at the core of the financial world. This book fills a noticeable gap in contemporary finance literature, which tends to focus on theory rather than practical application.
In the aftermath of the subprime mortgage crisis and ensuing credit crunch, the world of finance is returning to the fundamentals of valuation and critical due diligence for mergers & acquisitions (M&A), capital markets, and investment opportunities. This involves the use of more realistic assumptions governing approach to risk as well as a wide range of valuation drivers, such as expected financial performance, discount rates, multiples, leverage levels, and financing terms.

…

The valuation implied for a target by a DCF is also known as its intrinsic value, as opposed to its market value, which is the value ascribed by the market at a given point in time. Therefore, a DCF serves as an important alternative to market-based valuation techniques such as comparable companies and precedent transactions, which can be distorted by a number of factors, including market aberrations (e.g., the post-subprime credit crunch). As such, a DCF plays a valuable role as a check on the prevailing market valuation for a publicly traded company. A DCF is also critical when there are limited (or no) “pure play” peer companies or comparable acquisitions.
Part Two: Leveraged Buyouts (Chapters 4 & 5)
Part Two focuses on leveraged buyouts, which comprised a large part of the capital markets and M&A landscape in the mid-2000s.

…

The multiples paid for companies during this period quickly became irrelevant for assessing value in the following era.
Similarly, during the record low-rate debt financing environment of the mid- 2000s, acquirers (financial sponsors, in particular) were able to support higher than historical purchase prices due to the market’s willingness to supply abundant and inexpensive debt with favorable terms. In the ensuing credit crunch that began during the second half of 2007, however, debt financing became scarce and expensive, thereby dramatically changing value perceptions. As a result, the entire M&A landscape changed, including the volume of deals and buyers’ perspectives on valuation.
Deal Dynamics Deal dynamics refer to the specific circumstances surrounding a given transaction. For example:• Was the acquirer a strategic buyer or a financial sponsor?

In this case, if the stock price
exceeds $26 plus the premium that you received, your buy-write
strategy has underperformed the TSJ shares.
The Investopedia Guide to Wall Speak 57
Related Terms:
• Call Option
• Long (or Long Position)
• Strike Price
• Common Stock
• Stock Option
Credit Crunch
What Does Credit Crunch Mean?
An economic condition characterized by extreme difficulty in obtaining capital. Banks and investors become wary of lending funds
to corporations, and that drives up the price of debt products for
borrowers.
Investopedia explains Credit CrunchCredit crunches usually occur during recessions. A credit crunch
makes it nearly impossible for companies to borrow money because
lenders are scared of bankruptcies or defaults and charge higher interest rates because of that fear. The result is a slowdown in growth
that leads to a prolonged recession (or slower recovery), which is
compounded as banks hold tight to the banking reserves.

…

Bankruptcy
filings in the United States can fall under one of several chapters
of the Bankruptcy Code: Chapter 7 (which involves liquidation of
assets), Chapter 11 (company or individual “reorganizations”), and
Chapter 13 (debt repayment with lowered debt covenants or payment plans). Bankruptcy filings vary widely from country to country,
leading to higher or lower filing rates, depending on how easily a
person or company can complete the process.
Related Terms:
• Bear Market
• Credit Crunch
• Subprime Loan
• Chapter 11
• Debt
Basis Point (BPS)
What Does Basis Point (BPS) Mean?
A unit equal to 1/100 of 1%; it is used to denote a change in a financial instrument (usually a fixed-income security). The basis point
is used commonly for calculating changes in interest rates, equity
indexes, and the yield of a fixed-income security.
20 The Investopedia Guide to Wall Speak
Investopedia explains Basis Point (BPS)
Converting percentage changes in basis points is done as follows: 1%
change = 100 basis points, and 0.01% = 1 basis point.

…

A forbearance agreement is not a long-term
solution for delinquent borrowers; it is designed for borrowers who
have temporary financial problems caused by unforeseen problems
such as temporary unemployment or health problems.
Investopedia explains Mortgage Forbearance Agreement
Borrowers who are faced with mortgage financial problems such as
having chosen an adjustable-rate mortgage on which the interest
rate has reset to a level that makes the monthly payments unaffordable usually must seek remedies other than a forbearance agreement.
Related Terms:
• Bankruptcy
• Liability
• Subprime Meltdown
• Credit Crunch
• Mortgage
Mortgage-Backed Securities (MBSs)
What Does Mortgage-Backed Securities (MBSs) Mean?
Refers to a type of asset-backed security secured by a mortgage or a
collection of mortgages and grouped in one of the top two ratings
as determined by a credit rating agency such as Moody’s; usually
make periodic payments that are similar to coupon payments. Furthermore, the mortgages must have originated from a regulated and
authorized financial institution.

Indeed, it is one of three banks, excluding the Bank of England, permitted to issue UK banknotes.
Sadly, nowadays the Royal Bank of Scotland has become synonymous with the credit crunch because it needed to be bailed out by the government, a source of anger for many in the UK. It was deemed too big to fail.
At the time of writing the government owns 82% of the shares outstanding, having been forced to recapitalise the bank in order to prevent a run on the banking system. An Assassin bought shares in the Royal Bank of Scotland on 30 May 2008, before the collapse of Lehman Brothers and the onset of the credit crunch, at £22.29.
As the credit crisis broke, he actually moved quicker than his stop-loss, killing the investment on 3 October 2008 at £18.62, a loss of 16%. The stock then fell a further 82%.

…

CASE STUDY: BMW
What is there not to love about a car maker that has captured the imaginations of everyone from corporate fleet managers, who lease 3 Series saloons in staggering numbers, to middle-class mums ferrying their children around in its SUVs? Not to mention middle-aged men who try to recapture their youth driving the executive 6 or 7 Series or the Z4 Roadster …
One of my investors chose to invest in BMW on 11 April 2008 – just before the credit crunch hit – at a price of €34.95. He sold two months later on 23 June 2008 at a price of €32.35 for a loss of a mere 7%. Before you jump to conclusions, let me assure you that he did not sell because he foresaw the imminent credit crunch. He sold because a better idea had apparently presented itself.
The stock went on to return 95% after he sold it.
CASE STUDY: Pirelli
Sticking to the motoring theme, we go from German automotive powerhouse to Italian tyre manufacturing behemoth Pirelli. It is the fifth-largest tyre manufacturer in the world, behind Bridgestone, Michelin, Goodyear and Continental.

…

If you have ever been turned down for a loan following a credit check, chances are that the report the loan officer used to make his or her decision was generated by Experian.
This paints a picture of a rather bulletproof business model because so many companies rely on Experian’s reports in the day-to-day running of their businesses. What could possibly go wrong?
A Hunter bought the stock on 13 June 2006, at an initial price of £9.02 per share. Despite holding out through the credit crunch, this Hunter subsequently sold his entire stake five years later on 1 September 2011 with the shares trading at £7.06 per share. Had he done nothing, his patience as a buy-and-hold investor would not have been rewarded and he would have realised a loss of 22%. So much for the saying, ‘Time is your friend when losing’.
Fortunately, the Hunter had bought more shares in the company when they fell in price during that period.

This is an incredibly simple system, but even at this point it can give us some insights into why Bernanke’s QE1 was far less effective than he had hoped – and why it would have been far more effective if the money had been given to the debtors rather than to the banks.
A credit crunch
The crisis of 2007 was not merely a credit crunch (where the problem is liquidity) but the end point in the process of Ponzi lending that made much of the US economy insolvent. However, the credit-crunch aspect of this crisis can be simulated in this model by halving the rate at which the bank lends from the vault, and doubling the speed at which firms try to repay their debts. The time constant for bank lending therefore drops from ½ to ¼ – so that the amount in the vault turns over every four years rather than every two – while that for repaying debts goes from 1/10 to 1/5 – so that loans are repaid every five years rather than every ten.
The credit crunch has a drastic impact upon both bank account balances and incomes.

…

In the absence of instantaneous replacement cost pricing, firms must finance their increased working capital needs by increasing their borrowings from their banks or by running down their liquid assets. (Ibid.: 545)
Banks therefore accommodate the need that businesses have for credit via additional lending – and if they did not, ordinary commerce would be subject to Lehman Brothers-style credit crunches on a daily basis. The Federal Reserve then accommodates the need for reserves that the additional lending implies – otherwise the Fed would cause a credit crunch: ‘Once deposits have been created by an act of lending, the central bank must somehow ensure that the required reserves are available at the settlement date. Otherwise the banks, no matter how hard they scramble for funds, could not in the aggregate meet their reserve requirements’ (ibid.: 544).
Consequently, attempts to use the ‘Money Multiplier’ as a control mechanism – either to restrict credit growth as during the monetarist period of the late 1970s, or to cause a boom in lending during the Great Recession – are bound to fail.

…

This was followed by an era of increasing turbulence, which has continued until today’ (Minsky 1982: xiii).
Minsky’s judgment was based largely on his financial interpretation of the US business cycle from that point on:
The first serious break in the apparently tranquil progress was the credit crunch of 1966. Then, for the first time in the postwar era, the Federal Reserve intervened as a lender of last resort to refinance institutions – in this case banks – which were experiencing losses in an effort to meet liquidity requirements. The credit crunch was followed by a ‘growth’ recession, but the expansion of the Vietnam War promptly led to a large federal deficit which facilitated a recovery from the growth recession.
The 1966 episode was characterized by four elements: (1) a disturbance in financial markets that led to lender-of-last-resort intervention by the monetary authorities; (2) a recession (a growth recession in 1966); (3) a sizable increase in the federal deficit; and (4) a recovery followed by an acceleration of inflation that set the stage for the next disturbance.

Yet the ratio of a bank’s capital to its assets, technical though it may sound, is of more than merely academic interest. After all, a ‘great contraction’ in the US banking system has convincingly been blamed for the outbreak and course of the Great Depression between 1929 and 1933, the worst economic disaster of modern history.7 If US banks have lost significantly more than the $255 billion to which they have so far admitted as a result of the subprime mortgage crisis and credit crunch, there is a real danger that a much larger - perhaps tenfold larger - contraction in credit may be necessary to shrink the banks’ balance sheets in proportion to the decline in their capital. If the shadow banking system of securitized debt and off-balance-sheet institutions is to be swept away completely by this crisis, the contraction could be still more severe.
This has implications not just for the United States but for the world as a whole, since American output presently accounts for more than a quarter of total world production, while many European and Asian economies in particular are still heavily reliant on the United States as a market for their exports.

…

Europe already seems destined to experience a slowdown comparable with that of the United States, particularly in those countries (such as Britain and Spain) that have gone through similar housing bubbles. The extent to which Asia can ride out an American recession, in the way that America rode out the Asian crisis of 1997-8, remains uncertain. What is certain is that the efforts of the Federal Reserve to mitigate the credit crunch by cutting interest rates and targeting liquidity at the US banking system have put severe downward pressure on the external value of the dollar. The coincidence of a dollar slide and continuing Asian industrial growth has caused a spike in commodity prices comparable not merely with the 1970s but with the 1940s. It is not too much to say that in mid-2008 we witnessed the inflationary symptoms of a world war without the war itself.

…

Among them are many so-called distressed assets, which Griffin picks up from failed companies like Enron for knock-down prices. It would not be too much to say that Ken Griffin loves risk. He lives and breathes uncertainty. Since he began trading convertible bonds from his Harvard undergraduate dormitory, he has feasted on ‘fat tails’. Citadel’s main offshore fund has generated annual returns of 21 per cent since 1998.87 In 2007, when other financial institutions were losing billions in the credit crunch, he personally made more than a billion dollars. Among the artworks that decorate his penthouse apartment on North Michigan Avenue is Jasper Johns’s False Start, for which he paid $80 million, and a Cézanne which cost him $60 million. When Griffin got married, the wedding was at Versailles (the French château, not the small Illinois town of the same name).88 Hedging is clearly a good business in a risky world.

In the 1980s and 1990s, borrowing money was seen as a sign of economic shrewdness, rather than a matter of necessity. The developed world built an economic model on debt; consumers borrowed to finance their lifestyles, companies borrowed to enhance their returns, financial institutions borrowed more money to play the asset markets, countries borrowed money to tide economies over recessions. It may well be that the credit crunch of 2007 – 08 showed that this model had been tested to destruction. But what will replace it?
RUNNING ROUND IN CIRCLES
The Buddhists use a wheel of life to symbolize the cycle of life, death and rebirth. Religious scholars say that humans see everything from their own frame of reference, from their own point in the circle. Similarly, the economy flows in a circle, with money spent by one actor being received by the next.

…

The Thai crisis sapped confidence in the economies of other Asian nations and 1997 – 98 was a period of plunging crises, failed banks and recessions. Some countries were forced to turn to the IMF for assistance – a humiliation summed up in a picture of President Suharto of Indonesia signing a loan agreement in 1998, under the headmasterly eye of IMF officials. It was a determination to avoid a repeat of those events that led Asian nations to pursue their export-led policies in the 2000s; one of the factors that led to the credit crunch.
Iceland’s was an even more incredible story. A country of just 300,000 people on a remote island in the North Atlantic, best known for its fishing grounds and volcanoes, suddenly became a global financial power house. The carry trade led to an influx of capital in the 2000s; a strong currency allowed its entrepreneurs to go on a shopping spree for European businesses (including the West Ham football team and Hamleys toyshop, London’s equivalent of FAO Schwarz in New York).

…

The Europeans sought to escape this problem by clubbing together in a single currency, but eventually the strains had to show.
7
Blowing Bubbles
‘Stock market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.’
George Soros, hedge fund manager
Where did all the money go? My father-in-law asked that question in the aftermath of the credit crunch of 2007 and 2008, when house prices, share prices and corporate bond prices all tumbled. It seemed a reasonable point. If all the assets in the world were worth, say, $3 trillion one year and $2 trillion the next, what happened to that missing trillion?
To explain the answer, we have to turn to the career of Bernie Madoff, a convicted fraudster. Madoff was an American stockbroker who had a prominent role in the finance industry, serving as chairman of the board of directors of the National Association of Securities Dealers.

Most trudged along at two miles an hour, and nine out of every ten crossing the few hundred yards of their village would find an excuse to stop en route, often dithering along their brief way. The slump's poison had seeped out of silent factories, and ended up somewhere under the skin. We know all of this – and much more about daily life in this one tiny Austrian town in the 1930s – because pioneering young sociologists went there to find out what happens when everyone is thrown out of work, as virtually everyone had been when Marienthal's flax mill fell victim to the credit crunch of 1929.1
Eighty years later, a true economic hurricane again engulfed the rich world, for the first time since the 1930s. In the UK at least, the statistics confirm that national income took a bigger cumulative hit than during the Great Depression itself. You might imagine that there would be vast social consequences, but – thanks to the burgeoning of data and computers to crunch it – there is no need to rely on the imagination, or indeed on anecdotes from one village in the Austrian hills.

…

In his 2007 Budget speech, Chancellor Gordon Brown could boast that Britain was enjoying ‘the longest period of economic stability and sustained economic growth in our country's history’, just before he moved unchallenged into No. 10 Downing Street.1 The long expansion in the US economy had been briefly interrupted by 9/11, but felt just as assured. Few outside the financial sector discerned the first whispers of a credit crunch during that notably wet English summer,2 but then September brought something unseen since 1866 – a run on a British bank. It was not yet obvious that the queues of savers that formed outside branches of the smallish, provincial Northern Rock represented a threat to the financial universe as we knew it. But a year later – almost to the day – Lehman Brothers came crashing down in New York, heralding the start of the most catastrophic phase of the crisis.

By requiring AIG to post more collateral, the rating change deepened the company's woes to the point where death was averted only by an infusion of almost $130 billion in federal bailout money—a number that may grow.
The banks' uncertainty about the value of their mortgage-related assets and swap insurance and the magnitude of their swap liabilities curtailed — indeed, until the government stepped in, froze— lending. That was the "credit crunch." It caused both an immediate drop in economic activity and, in reaction to that drop and in anticipation of a further drop in the near future, a precipitous decline in the stock market. It started the dangerous spiral that we're in.
Ordinarily one would expect a credit crunch to be self-correcting. A shortage of capital for lending, due to the shrinkage of the banks' equity cushion, would attract new capital to banking, to rebuild the cushion. But that would depend on how much the cushion had shrunk and whether the crunch had so damaged the economy that the demand for loans would drop.

…

At least until the U.S. dollar ceases to be the world's principal reserve currency (a currency held by foreign banks as well as by the issuing country's own banks, and used as a major medium for international transactions), the federal government has almost unlimited capital because of its taxing, borrowing, and money-creating powers, and it is not constrained by having to make a profit or even cover its costs to survive. Government officials thought at first that the credit crunch was the result of a kind of panic —that the banks were scared to lend because they didn't know how thick their equity cushion was. If so, then by buying the mortgage-backed securities from the banks the government would dispel the panic and unfreeze lending. It would need to hold the securities that it had bought only until their value became clear; it would then sell them and recover the purchase price.

…

Other fortuities were a lame-duck Congress and a lame-duck President who seemed to lack interest or competence in handling economic issues and to prefer reminiscence, retirement planning, legacypolishing, and foreign travel to directing, and explaining to the public, the government's response to the biggest economic crisis in three quarters of a century. Still other fortuities were the indecisive, improvised, and inarticulate (though, eventually, aggressive) response to the crisis by government officials; a sudden collapse of much of the automobile industry as a delayed consequence of a surge in gasoline prices exacerbated by the credit crunch (two thirds of all cars are bought on credit); and the deepening of the economic crisis during a Christmas shopping season already foreshortened by a late Thanksgiving (November 27). Desperate to attract Christmas shoppers and avoid an inventory pileup, retailers offered unprecedented discounts. These discounts actually increased after Christmas, some reaching two thirds of the normal price.

One was in the Roaring Twenties, which led to a peak contribution by finance to the wider economy of nearly 6 per cent of GDP after the 1929 crash. The other was in the years before the recent credit crunch and subsequent collapse of Lehman Brothers. Even more impressive growth can be seen in the UK, where, over 160 years, financial services outstripped growth in the economy as a whole by 2 percentage points a year, accounting for no less than 9.4 per cent of GDP in 2006. In a less heavily regulated environment, UK bank balance sheets grew much faster than those in the US. Bank assets went from 50 per cent of GDP in the early 1970s to a phenomenal 500 per cent of GDP at the peak of the credit bubble. In both countries, national statistics point to a productivity miracle in the years before the credit crunch.68
There are some respectable reasons for the ascendancy of finance during the two spikes in financial activity.

…

The LSE backed down and took the money.
84 When Genius Failed: The Rise and Fall of Long-Term Capital Management, Random House Trade Paperbacks, 2000.
85 Dogs and Demons: The Fall of Modern Japan, Farrar, Straus & Giroux and Penguin Books, 2001.
86 ‘Letter from Chicago: After the Blow-up’, 11 January 2010.
87 In Going Off the Rails: Global Capital and the Crisis of Legitimacy, John Wiley, 2003, I argued that Federal Reserve chairman Alan Greenspan’s asymmetric and morally hazardous approach to monetary policymaking, which involved the repeated extension of a safety net to markets, was undermining capitalism’s immune system; the use of highly complex financial instruments meant that central banks and bank supervisors were over-dependent on experts in private banks to monitor the plumbing of the system and that supervision had been semi-privatised by default; financial institutions’ risk management was fundamentally flawed; financial innovation had failed to come up with any way of hedging against liquidity risk in banking; and the system’s pro-cyclicality was being exacerbated by the Basel capital adequacy regime. The book explained that the cycle would end with a credit crunch and system-wide deleveraging, creating severe deflationary pressure. In my columns at the FT before the credit crunch of 2007, I elaborated these arguments while highlighting excessive leverage in the system, the decline in bank lending standards and the risks inherent in the fast-growing shadow banking system. I did not, of course, accurately predict the timing of the bursting of the bubble.
88 ‘Expectations of Returns and Expected Returns’, 2012, http://www.hbs.edu/faculty/ Publication%20Files/expectedreturns20121020_00760bc1-693c-4b4f-b635-ded0e540e78c.pdf
89 Ibid.
90 http://www.economist.com/node/14165405
91 http://www.johnkay.com/2011/10/04/the-map-is-not-the-territory-an-essay-on-thestate-of-economics
92 Speech to the annual conference of the Institute for New Economic Thinking, quoted by Anatole Kaletsky in the International New York Times, April 2014.
93 Stabilizing an Unstable Economy, Yale University Press, 1986.
94 The Time of My Life, Penguin Books, 1990.
95 The trade-to-GDP ratio is the economy’s total trade of goods and services (exports plus imports) divided by GDP.
96 Politics, Book 7, Part 9, http://classics.mit.edu/Aristotle/politics.7.seven.html
97 http://classics.mit.edu/Plato/laws.html
98 Quote from Jerry Z.

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This contributes to inequality both inside companies and in society at large, leading to the kinds of discontent and alienation expressed by the Occupy movement across America in 2011 and 2012, along with similar protests around the world.
It is possible to put a case that manufacturing can shrink too far if international specialisation causes economies to suffer from a lack of diversity. That was the case with Britain, which was seriously under-diversified when the credit crunch struck in 2007. Back then, it derived more than 9 per cent of GDP from financial services. Yet it is also possible to suffer from a lack of diversification by dint of excessive exposure to manufacturing, as was the case with Germany at the same time. The Germans’ over-reliance on exports to drive economic growth meant that the collapse in world trade after the bankruptcy of Lehman Brothers in 2008 resulted in a greater percentage loss of output than in the US, which was the epicentre of the financial crisis.

Allowing weak or insolvent banks to continue operating—and especially supporting them with loans or loan guarantees—is costly and inefficient.13
When large banks and even an entire banking system are in trouble, politicians and supervisors fear that strict enforcement could cause a credit crunch and a recession.14 They believe that the time is not ripe to resolve the problems. Instead they allow insolvent or highly distressed banks to continue operating, and, if necessary, they provide bailouts.15 Research on banking crises, however, has shown that failing to deal with banking problems early and forcefully often results in more serious crises and in more severe credit crunches and recessions later.16 Kicking the can down the road can be very expensive.
Sometimes the concern is not just about the distress or hidden insolvency of individual banks. Individual banks may run into problems because there are too many banks in the market.

…

Regarding the contraction in repo lending, Krishnamurthy et al. (2012) show that lenders’ concerns about the value of the collateral could be traced to the private-sector issuers, in particular some key dealers such as Bear Stearns and Lehman Brothers. Krishnamurthy et al. (2012, 6) conclude that, in contrast to Gorton’s (2010) interpretation, the run on the repo markets “looks less like the analogue of a traditional bank run of depositors and more like a credit crunch in which dealers acted defensively given their own capital and liquidity problems, raising credit terms to their borrowers.” Credit crunches are actually due to the effect of debt overhang discussed in Chapter 3, which leads distressed lenders to avoid making loans that they would have made had they been less distressed.
55. As discussed by Skeel and Jackson (2012), rules from 1994 and their expansion in 2005 exempt repos and derivatives from automatic stays in bankruptcy and give them special preference.

…

The unprecedented decline in output in 2009 and the resulting loss of output have been valued in the trillions of dollars.19 The crisis has caused significant suffering for many.20 In light of these effects, warnings that greater financial stability would come at the expense of growth sound hollow. Warnings that bank lending would suffer also sound hollow. In 2008 and 2009, banks that were vulnerable because they had too much debt cut back sharply on their lending. The severe credit crunch was caused by banks’ having too much debt hanging over them.
Why would restrictions on bank borrowing have any effect on bank lending at all?
One argument was given in 2010 by the British Bankers’ Association, which claimed that new regulations would require U.K. banks to “hold an extra £600 billion of capital that might otherwise have been deployed as loans to businesses or households.”21 To anyone who does not know what the regulation is about, this argument may look plausible.

Currently, as infrastructure crumbles in the United States and in many other nations, and
the availability of high-quality education and health care plummets,
with massively underfunded liabilities, the stark statistics still don’t tell
the full story of America’s sons and daughters and, indeed, the entire
global family as it grapples with an uncertain future. The situation is
particularly dire in Europe: Greece, Spain, Ireland, the United Kingdom, and Italy are in a credit crunch not seen in generations. Even in
the countries that were up until recently considered booming, nations
like the BRICs—Brazil, Russia, India, and China— development was
highly uneven, with entire regions experiencing scarcity and need.
Now it would appear that their economic bloom is wilting.10 Practically
everywhere one finds many tales of how the highly competitive nature
of the conventional money system influences our lives.

…

THE DASH FOR CASH
Beyond the daily monetary mêlée that is playing out on the personal
level, some 44 states in the Union are considering bankruptcy,20 and
dozens of cities across the nation are faced with inevitable budget shortfalls.21 The river port city of Stockton, California, is the largest U.S. city
to lately declare bankruptcy.22 In the meantime, at various levels of officialdom globally, it’s believed that the only way out of the current
credit crunch, on the present trajectory, is the forfeiture of assets in the
blaze of fire sales.
Some 28 states have passed private public partnerships (PPPs) enabling statutes.23 Despite the benign-sounding label, these statutes
mean that governments—at whatever level—are selling off existing infrastructure that has already been built and paid for with taxpayers’
money to reduce existing debt, if they are unable to meet current governmental expenses.

…

Prior to working with
us, he had initiated a program in Uruguay and introduced IT and new
technologies and other innovations. It turned out to be a very successful project that led to Uruguay being one of the most advanced countries in that business.”6
Van Arkel and he together designed a currency that would address
the critical issue of cash flow facing small and medium-size enterprises
when their suppliers extend credit for 30 days while their larger customers may not pay for 90 days. Often there’s a credit crunch, as banks
refuse to provide bridge financing or do so subject to very onerous conditions. Furthermore, if the business is a new one, a credit line can be
virtually impossible to secure. These problems are endemic in businesses in both developing and developed countries.
The solution that emerged is called the Commercial Credit Circle,
or C3 for short. The C3 plan uses insured invoices or other payment
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PROSPERITY
claims as backing for a liquid payment instrument within a businessto-business clearing network.

This book traces the rise and fall of free market ideology, which, as Greenspan said, is more than a set of opinions: it is a well-developed and all-encompassing way of thinking about the world. I have tried to combine a history of ideas, a narrative of the financial crisis, and a call to arms. It is my contention that you cannot comprehend recent events without taking into account the intellectual and historical context in which they unfolded. For those who want one, the first chapter and last third of the book contain a reasonably comprehensive account of the credit crunch of 2007–2009. But unlike other books on the subject, this one doesn’t focus on the firms and characters involved: my aim is to explore the underlying economics of the crisis and to explain how the rational pursuit of self-interest, which is the basis of free market economics, created and prolonged it.
Greenspan isn’t the only one to whom the collapse of the subprime mortgage market and ensuing global slump came as a rude shock.

…

“The assumption of ‘rational expectations’ as a modeling device is now entirely orthodox,” Michael Woodford, one of the leading New Keynesians, wrote in 1999.
The third-generation rational expectations models can be useful for exploring the old question of how central banks should set interest rates to achieve a low and stable rate of inflation, but they have virtually nothing to say about what policymakers should do to maintain financial stability. As in the original Lucas models, there is no role in them for stock market bubbles, credit crunches, or a drying up of liquidity. Indeed, recognizable financial markets don’t really exist. The illusions of harmony, stability, and predictability are maintained, and Hayek’s information processing machine does its job perfectly: at all times, prices reflect economic fundamentals and send the right signals to economic decision-makers.
Even the creators of these models concede that they don’t provide any guidance for policymakers in times of financial turbulence.

…

Fearing that new borrowers will be more likely to default, banks have strong incentive to curtail lending. But if they do this, businesses will be deprived of credit; the economic downturn and the problem of adverse selection will only get more acute. In extreme circumstances, the entire lending market might freeze up.
In solving one set of information problems, banks create others, of which the possibility of a credit crunch is but one example. Since banks don’t publish a list of all the loans they have made, the typical bank customer doesn’t really know if his bank is sound. If his deposits aren’t guaranteed, he has every incentive to withdraw his savings at the first sign of trouble. Since each depositor is in the same position, the possibility of a “run” on the bank is very real. Between 1929 and 1932, more than five thousand banks went out of business, and in early 1933, there was another big wave of failures as depositors in many states rushed to get out their money.

Despite its obvious bias, the account is interesting because it was published in April 2008, five months before the dramatic fall of Lehman Brothers in September of that year, which was the moment when the crisis took on truly global dimensions. ‘The trigger for the credit crunch’, wrote Blackburn, ‘was rising defaults among US holders of subprime mortgages in the last quarter of 2006 and early 2007.’ This led to the failure of ‘several large mortgage brokers in February–March 2007’. The analysis shows the impact which the credit crunch had on a frightened world at the end of 2007.
‘The subprime debacle and the drying up of credit, themselves the consequences of deteriorating conditions, were hastening the slide to recession in the US and the global economy.’ The ‘credit crunch’ itself came as ‘the climax of a long period of gravity-defying global imbalances and asset bubbles’. It was ‘Fear of recession that had prompted the US Federal Reserve to keep interest rates low in 2001–06.’

…

Gold would reach an all-time high in January 1980 of US$850 an ounce, a level which would not be attained again for nearly twenty-five years.49
The Fed’s discount interest rate rose from 13.5 per cent to a new peak of 14.5 per cent in October 1979, and commercial banks like Chase Manhattan increased their rates in response. Controlling the money supply would prove challenging for the Federal Reserve. One considerable danger continued to be ‘the threat of an outright credit crunch’, in the words of Time magazine in its October 1979 piece. Such an eventuality would occur if the ‘Federal Reserve’s tightening up of money, and the resulting rise in interest rates, reach such levels that borrowers found it impossible to get money on almost any terms’.50 The situation outlined in this scenario was classical in its character. A rise in interest rates had notoriously forced Wall Street into the death spiral of the end of 1929.

…

It was widely accepted that tight money could strangle business investment, and that the most effective means of achieving this outcome was through an overly aggressive increase in interest rates. Time recalled that such a ‘squeeze [had] occurred in the summer and fall of 1974, and almost immediately forced businesses to lay off upwards of 2 million workers’.
With admirable realism, the article proposed that ‘something like a credit crunch may be the only thing that can break the nation’s addiction to easy money’. Volcker, Time concluded, ‘had brought monetary policymaking fully into the fight to hold prices down’. The President had insisted at a press conference towards the end of October 1979 that ‘whatever it takes to control inflation, that’s what I’ll do’. This marked a change from the rhetoric with which he had begun his presidency, when the main worry was employment.

The stability witnessed since World War II in the U.S. economy may
ironically be a cause of economic instability, which could be deepened
and extended in duration should cultural and political factors align in
complete support of socialism. Whenever there has been a recession, rates
have been lowered and liquidity injected such that the impact of credit
default was diluted. Although this avoided long, deep recessions, it has
encouraged greater and greater waves of risk taking.
What did the American public know of the credit crunch? Amazingly,
a survey of 1,361 homeowners released in August 2008 and conducted by
Harris Interactive for Zillow, an Internet-based provider of home valuations derived from the collection of last sale public records and proprietary algorithms, revealed that 62 percent of homeowners thought their
home value had increased or remained the same in the last year! In fact,
77 percent of U.S. homes lost value in the 12 months preceding the survey.

…

Its growth, periodic overexpansion, and contraction
46
ENDLESS
MONEY
became the DNA encoding cyclicality to the economic corpus, but the
use of silver and gold at the base provided restraint that would reign in
moral hazard and provide a safe haven for savers. However, when specie
conversion was suspended, it would set the stage for even larger catastrophes, a point that might well be taken when evaluating the Fed’s
actions in combating the credit crunch of 2008.
The practice of using credit as currency had actually begun in
England. Charles I borrowed gold on deposit from merchants at the
mint to help finance a civil war. After this gold was returned, merchants sought to avoid the state’s involuntary usage of their wealth by
keeping it at goldsmiths instead, who issued receipts for the inventory.
The receipts were used as a form of currency and were issued in excess
of the gold held, thus giving birth to “fractional reserve” banking at
about the same time as the Massachusetts colony began its paper currency system.

…

Such a policy would also rescue failing financial institutions and further consolidate the financial industry,
as well as eventually bail out homeowners. The Fed and the mortgage agencies in this context may be seen as supplementary organs of
120
ENDLESS
MONEY
government (such as the Supreme Court), which are moving to compliment the axis of dependency and the modern technocratic state.
There was a great debate among market observers as the credit
crunch became virulent in late 2008 between whether there would be
deflation or inflation, assuming away the base case of muddling through
for the moment. Those who rooted for the deflationist camp looked to
the depression years and saw a consumer heavily laden with debt and
a highly leveraged banking system wherein over half of its loans relate
to real estate.6 They saw interest rates at generational lows already, with
the Fed discount rate near zero by year-end 2008.

Some hapless insurance syndicates discovered that they had insured Piper Alpha many times over. Parts of the spiral are still being unwound over two decades later.
If this sounds familiar, it should. Within the first few days of the credit crunch in 2007, long before most people were aware of the scale of the trouble, the economist John Kay was pointing out the similarities between the crunch and the LMX spiral. As in the credit crunch, financial institutions and regulators told themselves that sophisticated new financial tools were diluting risk by spreading it to those best able to cope. As in the credit crunch, historical data suggested that the packaged reinsurance contracts were very safe. And as in the credit crunch, the participants found the true shape of the risk they were taking almost impossible to discern until after things had gone horribly wrong. In both cases, innovative financial techniques proved to be expensive failures.

…

This not only reduces the chance that an individual bank will fail, but also reduces the chance that the failure will spread. Banks will not voluntarily carry thick cushions of capital, so regulators have to force them, and there is a cost to this. Capital is expensive, so higher capital requirements are likely to make loans and insurance more costly. It is possible to have too much of a good thing, even capital. But the credit crunch made it clear that the banks were carrying too little.
The second possible safety gate involves the curiously named ‘CoCo’ bonds – short for contingent convertible bonds. CoCos are debt, so under normal circumstances CoCo holders are paid interest and take priority over shareholders just as ordinary bank creditors do. But a CoCo is a bit like an airbag: if the bank crashes, it suddenly turns into a cushion, converting from bond to capital.

Prior to 2008, as we now know, Wall Street had managed to set up a parallel monetary system, a form of private money, underwritten by the capital inflows toward the Global Minotaur. The global economy became hooked on that toxic money, which, by its nature, divided and multiplied unsustainably. So when it turned to ashes, world capitalism crashed. If it were not for the lessons that the central banks had learned from the Crash of 1929, the repercussions would have been unimaginable – as opposed to just frightful.
Chronicle of a Crash foretold: Credit Crunch, bailouts and the socialization of nearly everything
2007 – The canaries in the mine
April – New Century Financial, a mortgage company that had issued a great number of sub-prime mortgages, goes under, with reverberations throughout the sector.
July – Bear Stearns, the respected merchant bank, announces that two of its hedge funds will not be able to pay their investors their dues. The new chairman of the Fed, Ben Bernanke (who had only recently replaced Alan Greenspan) announces that the sub-prime crisis is serious and its cost may rise to $100 billion.

…

Bush, gives the first indication of the world’s biggest government intervention (not excepting that of Lenin after the Russian Revolution). On 6 December, President Bush unveils a plan to help a million American homeowners avoid having their houses confiscated by the banks (i.e. avoid foreclosure, in American parlance). A few days later, the Fed gets together with another five central banks (including the ECB) to extend almost infinite credit to the banks. The aim? To address the Credit Crunch – i.e. the complete halt in inter-bank lending.
2008 – The main event
January – The World Bank predicts a global recession, stock markets crash, the Fed drops interest rates to 3.5 per cent, and stock markets rebound in response. Before long, however, MBIA, an insurance company, announces that it has lost $2.3 billion from policies based on bonds containing sub-prime mortgages. These insurance policies suddenly become household names: they are known as credit default swaps, or CDSs.

…

Wall Street’s fifth-largest bank, Bear Stearns (which in 2007 was valued at $20 billion) is wiped out, absorbed by JPMorgan Chase, which pays the paltry sum of $240 million for it, with the taxpayer throwing in a subsidy in the order of $30 billion.
April – It is reported that more than 20 per cent of mortgage ‘products’ in Britain are being withdrawn from the market, along with the option of taking out a 100 per cent mortgage. Meanwhile, the IMF estimates the cost of the Credit Crunch to be in excess of $1 trillion. The Bank of England replies with a further interest rate cut to 5 per cent and decides to offer £50 billion to banks burdened with problematic mortgages. A little later, the RBS attempts to stave off bankruptcy by trying to raise £12 billion from its shareholders, while at the same time admitting to having lost almost £6 billion in CDOs and the like. Around this time house prices start falling in Britain, Ireland and Spain, precipitating more defaults (as homeowners in trouble can no longer even pay back their mortgages by selling their houses at a price higher than their mortgage debt).

What they
published in July 2008 was known as the ‘Green New Deal’, launched 75 years after
President Roosevelt launched a New Deal to rescue the USA from financial crisis.5
The Green New Deal urged governments to embrace a comprehensive, selfreinforcing programme including to:
•
•
•
•
•
•
•
invest in a major programme of renewable energy and wider environmental transformation that would create thousands of new green collar jobs;
build a new alliance between environmentalists, industry, agriculture and unions
to put the interests of the real economy ahead of those of footloose finance;
set up an Oil Legacy Fund, paid for by a windfall tax on the profits of oil and gas
companies, as part of a wide-ranging package of financial innovations and incentives to assemble the tens of billions of pounds that need to be spent, including
local authority green bonds, green gilts and green family savings bonds;
make sure fossil fuel prices include the cost to the environment, and are high
enough to tackle climate change by creating economic incentives to drive
efficiency and bring alternative fuels to market;
cut corporate tax evasion by clamping down on tax havens and corporate financial reporting;
re-regulate the domestic financial system, inspired by reforms implemented in the
1930s, including cutting interest and much tighter regulation of the wider financial environment;
break up the discredited financial institutions that have needed so much public
money to prop them up in the latest credit crunch.
Taken together, the Green New Deal urged a programme of re-regulating finance and
taxation plus a huge transformational programme aimed at substantially reducing the
use of fossil fuels and, in the process, tackling the unemployment and decline in
demand caused by the credit crunch. It involved policies and new funding mechanisms that will reduce emissions and allow us to cope better with the coming energy
shortages caused by peak oil. The importance was not so much the details of the plan,
but its pattern. What the Green New Deal understood was that these crises needed to
be tackled together, in a way that modern government finds difficulty doing.

…

Limit the amount people can borrow
It is increasingly clear that using mortgages as the main way we inject money into the
financial system has, at the very least, put an incredible strain on house prices. These
have certainly risen because of a shortage of homes in places where people want to
live and the influx of wealthy people into the UK – especially London – but mainly
because of an inflationary increase in the amount of money that people can borrow
for a mortgage. Before the credit crunch, this was anything up to six times their
salary. It is no coincidence that the country that introduced ‘grandparent mortgages’,
paid off by the generation after next (Japan), also suffers from the highest property
prices in the world, and some people in Tokyo are reduced to living in what is little
more than a tube. The best way of bringing prices down is credit controls.
Reward people’s effort in the community
We need institutions like time banks that are capable of drawing on the assets of other
groups – including older people as foster grandparents, for example – to generate
92
THE NEW ECONOMICS
better support systems for families and communities.

…

Evidence obtained from the insider trader Ivan
Boesky led to Wall Street’s biggest criminal prosecution ever (at least until the Bernard
Madoff affair in 2008), after which 98 indictments of fraud and racketeering were
brought against Milkin. He was sentenced to ten years in jail and agreed to pay $600
million in fines. Without his leadership, the junk bonds faltered. It is widely believed
that the temporary decline of the junk bond market led to a credit crunch that
contributed to the 1990 recession. Milken was released from prison early because he
had been given only 18 months to live, and now runs his own economic think tank.
But one of the legacies of those years has been the defensive loading of companies
WHY ARE MALAWI VILLAGERS PAYING THE MORTGAGES OF STOCKBROKERS?
143
with debt in order to stave off hostile takeovers, while those that have been successfully seized are anyway loaded with vast debt.15 Debt has, in short, become a way of
life for corporations.

They may occasionally use tools, they may occasionally shift their ecological niche, but they do not ‘raise their standard of living’, or experience ‘economic growth’. They do not encounter ‘poverty’ either. They do not progress from one mode of living to another – nor do they deplore doing so. They do not experience agricultural, urban, commercial, industrial and information revolutions, let alone Renaissances, Reformations, Depressions, Demographic Transitions, civil wars, cold wars, culture wars and credit crunches. As I sit here at my desk, I am surrounded by things – telephones, books, computers, photographs, paper clips, coffee mugs – that no monkey has ever come close to making. I am spilling digital information on to a screen in a way that no dolphin has ever managed. I am aware of abstract concepts – the date, the weather forecast, the second law of thermodynamics – that no parrot could begin to grasp.

…

Japan spent the first half of the twentieth century jealously seeking to grab resources and ended up in ruins; it spent the second half of the century trading and selling without resources and ended up topping the lifespan league. In the 2000s the West misspent much of the cheap windfall of Chinese savings that the United States Federal Reserve sluiced our way.
So long as somebody allocates sufficient capital to innovation, then the credit crunch will not in the long run prevent the relentless upward march of human living standards. If you look at a graph of world per capita GDP, the Great Depression of the 1930s is just a dip in the slope. By 1939 even the worst-affected countries, America and Germany, were richer than they were in 1930. All sorts of new products and industries were born during the Depression: by 1937, 40 per cent of DuPont’s sales came from products that had not even existed before 1929, such as rayon, enamels and cellulose film.

…

He is not necessarily wrong about some speculative markets in capital and in assets, but he is about markets in goods and services. The notion of synergy, of both sides benefiting, just does not seem to come naturally to people. If sympathy is instinctive, synergy is not.
For most people, therefore, the market does not feel like a virtuous place. It feels like an arena in which the consumer does battle with the producer to see who can win. Long before the credit crunch of 2008 most people saw capitalism (and therefore the market) as necessary evils, rather than inherent goods. It is almost an axiom of modern debate that free exchange encourages and demands selfishness, whereas people were kinder and gentler before their lives were commercialised, that putting a price on everything has fragmented society and cheapened souls. Perhaps this lies behind the extraordinarily widespread view that commerce is immoral, lucre filthy and that modern people are good despite being enmeshed in markets rather than because of it – a view that can be heard from almost any Anglican pulpit at any time.

Dugan began to push aggressively for regulatory guidance that would instruct banks to evaluate mortgage applicants on the basis of their ability to pay the eventual adjusted rate—not just the teaser.
But Dugan needed the cooperation of the Fed, as well as the Federal Deposit Insurance Corporation and the Office of Thrift Supervision (OTS), which proved slow going. His fellow regulators—in particular the OTS, which supervised highfliers such as Countrywide and WaMu—worried that if they shut down or even narrowed the loan channel, they could precipitate a credit crunch. And Greenspan was philosophically, perhaps reflexively, opposed to restricting credit.
By the end of 2005, Dugan had coaxed the group into issuing tentative rules, but these were subject to a comment period, and the mortgage industry was hotly opposed. For one, they said, if federally chartered banks were subject to tighter guidelines, applicants would seek out state banks and nonbanks. Also, banking executives reiterated that they were quickly selling the loans, removing the risk (or rather, transferring it to investors outside the OCC’s domain).

…

Perhaps he had cause, for Lehman suffered a near-death experience almost every market cycle. In 1998, when the hedge fund Long-Term Capital Management imploded, seeming to imperil Wall Street, Fuld valiantly went on the road to keep Lehman’s creditors from withdrawing their lines of credit; his efforts saved the firm. He had the daring of a gambler who believes, deep down, that he will always be able to play the last card—that if down markets or a credit crunch ever swamped his firm, he would find a way to steer it home.
Fuld had attended the University of Colorado, and his middling education left him deeply insecure among polished Ivy League investment bankers. In other respects, he was a typical Wall Street CEO. His trader’s gruffness, his guttural barking, had been moneyed over. His ambition had been answered with a growing reputation, and with eight-figure paychecks and all they provided: his wife’s auction-quality art collection and board seat at the Museum of Modern Art; homes on Park Avenue and in Greenwich, Connecticut, Sun Valley, Idaho, and Jupiter Island in Florida.

It also felt more like what has been going on in the real world in the past five years, as market prices for corn and rice, vegetable oil and coffee, wheat and sugar have yo-yoed like the stakes in some demented game. Perhaps I had misunderstood the hidden hand of the market, and my own hidden altruism? I hoped to find out more in the displays about the illustrious history of CBOT. But, strange to say, the timeline stopped just before some of the biggest events in this place’s history—the 2008 food price spike, the subsequent crash following the credit crunch, and the new surge in prices that was roaring as I toured the exchange in late 2010.
I left confused and decided to go for a McDonald’s. I figured that, even more than the bowl of corn flakes, a Big Mac was now the ultimate modern consumer expression of the trading I had just watched. But, outside the exchange, my eye was caught by Harper’s magazine on a newsstand. The cover story was titled “The Food Bubble—How Goldman Sachs and Wall Street Starved Millions and Got Away with It.”

…

The distinguished Indian economist Jayati Ghosh said later: “From about late 2006, a lot of financial firms realized that there was really no more profit to be made in the US housing market.” They switched to commodities and began pushing up prices “so that what was a trickle in late 2006 becomes a flood from early 2007.”
As the prices of shares, real estate, and other former wealth generators fell during the credit crunch of 2008, the prices of commodities index funds continued to rise, as investors poured in. This accelerated as governments in the United States and Europe tried to save the world banking system by pumping in new money—quantitative easing. Much of this new money, we now know, went straight into commodities. In 2003, there had been $13 billion in agricultural commodity funds. But by 2008, many commentators put the figure at over $300 billion.

…

The veteran chief minister of Sarawak, the Borneo province of Malaysia, was looking for Gulf investment in his “Halal hub,” 190,000 acres of former rain forest being turned into farms for him by a Taiwanese company. Abdul Taib Mahmud, who is old enough to remember the Japanese landing in Borneo during the Second World War, was undaunted by fears of a new land invasion. He returned with a promise of a billion dollars from Perigon Advisory, an investment fund based in Bahrain.
For a while in 2009, Gulf investors showed signs of getting cold feet, as the credit crunch created the debt crisis that almost engulfed the region’s most visible totem of wealth, the desert megacity of Dubai. Some deals were quietly put on hold or dropped. Abu Dhabi’s Al Qudra Holding had promised in 2008 to acquire 1 million acres in a host of countries from Australia to Eritrea, Croatia to Thailand, and Ukraine to Pakistan. The first harvests, said CEO Mahmood Ebrahim Al Mahmood, would be shipped during 2011.

The Western World’s Two Distinct Problems
The first problem the OECD faces is that from 2000 to 2010 the private sector created a lot of assets (real estate in the United States, Spain, the United Kingdom, Ireland, etc.) against which a considerable amount of debt has been collateralized by commercial banks. As the prices of these assets fall, a Fisher-like “debt deflation” looms.
The second problem is that, for structural reasons, a growing number of OECD countries are confronting a very challenging budgetary situation. The credit crunch, bank bailouts, and recession only account for 9 percent of the increase in long-term public debt burdens in major advanced economies. The remaining 91 percent of the long-term fiscal pressure is due to the growth of public spending on pensions, and health and long-term care. In other words, the credit crunch and recession did not create the present pressures on public borrowing and spending. They merely brought forward an age-related fiscal crisis that would have become inevitable once a majority of the baby boomers retired around 2020.
The solution to the first problem is simple monetary economics 101: Central banks have to buy assets in the hope of preventing a collapse in asset prices.

…

The recovery has taken many by surprise because of the severity of the crisis in the financial markets in late 2008. The stock market fell sharply. The commercial paper market froze. Bond spreads rose to unprecedented levels. Bankers cut credit lines. Consumers reacted to these shocks by slashing their spending, especially in up-market retailers. Corporations sharply curtailed capital spending. As the credit crunch hit the global economy, exports fell sharply as well.
How Government Intervention Ended the Financial Crisis
Government intervention rescued the economy. The Federal Reserve slashed interest rates to zero and expanded its balance sheet from $900 billion to $2.2 trillion by injecting large amounts of liquidity into the financial system. After the Lehman Brothers bankruptcy, the Treasury Department persuaded Congress to approve the $700 billion TARP rescue package.

…

Looking at the eurozone as a whole, the fiscal outlook also contrasted favorably with that of the United States, Britain, and Japan. Public spending control had been surprisingly effective in most of Europe during the recession, and indeed in the decade before, in contrast to the free-spending policies advocated in the United States by the Obama administration, and practiced covertly by the Bush administration and the Brown government in Britain in the years leading up to the credit crunch.
None of this means, however, that the eurozone is about to emerge in 2011 from its long period of economic underperformance in relation to the United States and Britain. Neither does the recent contrast between the bullish sentiment in Europe and the pervasive gloom in the United States and Britain imply that Anglo-Saxon macroeconomic policies of aggressive monetary and fiscal stimulus were counterproductive.

But the most disquieting part isn't the remark itself. It's the fact that no one else seems the slightest bit taken aback. You look around in vain, hoping for even a flicker of concern or the hint of a cringe.
I had one of those moments at a friend's dinner in a gentrified part of East London one winter evening. The blackcurrant cheesecake was being carefully sliced and the conversation had drifted to the topic of the moment, the credit crunch. Suddenly, one of the hosts tried to raise the mood by throwing in a light-hearted joke.
'It's sad that Woolworth's is closing. Where will all the chavs buy their Christmas presents?'
Now, he was not someone who would ever consider himself to be a bigot. Neither would anyone else present: for, after all, they were all educated and open-minded professionals. Sitting around the table were people from more than one ethnic group.

…

The crisis may have been caused by the greed of bankers, but manufacturing paid the price. It lost well over twice the proportion of jobs as finance and business services in the first year of the crisis. The City's share of the economy has actually grown since 2005, leaving us more dependent on the part of the economy that caused the crash in the first place. As former City economist Graham Turner puts it, it is 'a staggering outcome of this credit crunch'.
With industrial jobs steadily drying up, it might seem bizarre that the British public stubbornly continues to self-identify as working class. Matthew Taylor recalls reactions to Blair's 'we're all middle class' speech: 'It was quickly pointed out that, interestingly, more people in Britain call themselves working class now than did in 1950.' Opinion polls show that over half the population consistently describes itself as working class, but one poll in 1949 recorded it as just 43 per cent.2That was a time when there were a million miners, most people worked in manual jobs and rationing was still in full swing.

…

The living standards of some working-class people are lower than they would have been if they were paying cheap council rents rather than often very expensive mortgages. Indeed, over half the people living in poverty are homeowners. There are actually more homeowners in the bottom 10 per cent (or decile) than there are in each of the two deciles above it. As we know, encouraging so many people to take on unaffordable levels of debt had a detonator role in the credit crunch. In any case, as more and more people have become priced out of home ownership, ithas gone into reverse: peaking at 71 per cent in 2002-03 and falling back to 68 per cent six years later.
If it is not community, income or living arrangements that defines the working class, what isit? Neil Kinnock may be the Labour leader who laid the foundations for the party's dramatic swing to the right, but he still feels most comfortable with how Karl Marx put it.

In response, the German government announced a 500-billion-euro bank-bailout fund in late 2008. Germany got nervous again in 2009 when several Landesbanken, Germany’s public-private regional development banks, which had, it turned out, also been investing in toxic US assets, got into trouble. But their losses, too, were easily dealt with. By the end of 2009, the German banking system was stable, if not healthy. What worried the Germans was how the global credit crunch would affect their exports—their growth machine—not exposure to US subprime mortgage bonds.
Those fears seemed justified when, in the fourth quarter of 2008, German exports contributed 8.1 percent of an overall 9.4 percent annualized decline in GDP.5 By mid-2009, the Bundesbank was forecasting a 6 percent GDP contraction by the end of the year. Surprisingly robust demand in Asia, however, made up for declines in the Euro Area.

…

And while everyone seemed to know that the explosion had something to do with asset bubbles and banks, at the start of the crisis few had a convincing story about how the banks had caused it. This is where the Austrians came back in. Their writings from the 1930s seemed to describe the 2008 financial crisis perfectly. Its aftermath, and what to do about it, was to prove another matter entirely.
The Hayek/Mises Model of Credit Crunches and Collapses
Writing in the 1920s, Hayek and Mises drew attention to the rather obvious fact that banks make money from the extension of credit. And while each bank may wish to be prudential, each has an incentive to expand credit beyond its base (at that time, gold) reserves to stay in business against more aggressive banks and/or capture market share. Moreover, banks are encouraged to do so by the presence of a central bank that backstops the financial system with liquidity.

…

All that was needed to make this whole system explode was a detonator—and the foreign banks provided that too.
Yet Another Banking Crisis
The 2008 crisis hit the REBLLs as a combination of a current account crisis—exports slumped as financing for imports dried up and deficits, already large, exploded—and the bursting of real estate bubbles once the foreign banks that owned their financial sectors tried to cover their losses in the credit crunch. As we discussed back in chapter 2, when a bank makes a loss in one part of its portfolio, it looks to liquidate assets elsewhere in the portfolio to cover those losses.161 The REBLLs were the very definition of “elsewhere in the portfolio.” Worried about the solvency of their home-base operations in the aftermath of the Lehman crisis, the parent banks of these REBLL banks let it be known to the REBLL governments that they were considering pulling out of their countries to supply much-needed liquidity to their core (home) operations.162 Given the extremely open and market-friendly economic institutions of the REBLLs, these states had no way to keep capital at home.

For example, Senator Levin, at the Senate Permanent
Subcommittee on Investigations hearings into ABACUS-AC1, raised a series
of ethical questions, including the duty of care of investment banks to
clients, and whether investment banks should sell products in which they
do not believe.
Much of the financial crisis was not novel
It is also worth looking back at previous banking crises to assess how much
of the recent crisis is novel, and whether there are ethical implications
for investment banks. A number of the areas of concern in the credit
crunch were clearly understood to be existing problems from previous
crises:
• The unreliability of credit ratings, including multi-notch downgrades
and allegations of conflicts on interest was a major area of concern in the
wake of the Enron and WorldCom credit downgrades and bankruptcies
in 2001–2. These bankruptcies were not alone, as there was a series of
failures in both the telecoms/cable and the independent power producer
sectors.

…

Given the nature of a sovereign country, and its responsibilities (providing services such as health care, defence, education) for and from (e.g.,
tax raising) its citizens, the ethical position of trading in sovereign debt
may have different characteristics than trading in corporate debt.
• Strategies involving short-selling are not novel. George Soros was shorting the pound when he famously profited from the UK’s attempt to
remain in the European Exchange Rate Mechanism (ERM) in 1992.
• The proximate cause of the credit crunch – mis-selling of high-risk mortgages in the US – is reminiscent of other mis-selling problems in the
past, such as the IPO of some dotcom stocks and the sale to retail
customers of endowment plans in the UK, although the economic damage from the sub-prime crisis was significantly greater than in previous
cases.
18
Ethics in Investment Banking
The positive impact of investment banking
Although investment banking has received much recent criticism, it has
also made positive contributions to society both directly and indirectly.

…

Questions were also raised about
investment banks’ attitudes to clients.
Some investment banks’ high-risk operations, which contributed to causing a recession, also raised questions about the banks’ duties to society
at large and their apparent lack of awareness of wider responsibilities.
In a letter sent from the learned society, the British Academy, to Queen
Elizabeth II in response to her question, “why had nobody noticed that
the credit crunch was on its way?” its authors, Professors Tim Besley and
Peter Hennessy, describe “a failure of the collective imagination of many
bright people, both in this country and internationally, to understand the
risks to the [economic] system as a whole”.2
The financial crisis also raised fundamental questions about the creation
of complex financial instruments that contributed to market instability.

And little matter that Europe could not project the same military force as the United States; Europe saw itself as a “normative power”, able to influence the world through its ability to set rules and standards. Some Europhiles even imagined that Europe would “run the 21st century”, as the title of one optimistic book put it.1
The collapse of subprime mortgages in the United States, and the credit crunch that followed, only confirmed such convictions. The single currency, the European Union’s most ambitious project, was seen as a shield against financial turbulence caused by runaway American “ultra-liberalism”, as the French liked to describe the faith in free markets. But when the financial storm blew in from across the Atlantic, the euro turned out to be a flimsy umbrella that flopped over in the wind and dragged away many of the weaker economies.

…

The real failing of the pact was that an obsession with budgets, especially the annual deficits, blinded ministers and officials to more serious underlying problems in the euro zone. “The whole system was looking at the economy through the keyhole of fiscal policy,” says one Commission veteran. By 2007 the fiscal situation had seemingly never been better. All members of the euro zone were out of the excessive deficit procedure (EDP) by mid-2008, and so formally deemed to have their public finances in order though the credit crunch was intensifying. The Commission boasted that reform of the pact had promoted discipline and national “ownership”. Even Greece was released from the EDP in 2007, despite persistent doubts about the reliability of its figures. But, rather as with the enforcement of the pact, governments would not hear of the Commission being given the power to audit their national figures.
It is significant that, on the eve of the crisis, three of the five countries that would later have to be bailed out – Ireland, Spain and Cyprus – were virtuous by the standards of the stability and growth pact.

…

The violence seemed to reflect a deep malaise over high youth unemployment, a dynastic political system based on patronage, a kleptocratic and ineffective public administration, educational reforms – and the public bail-out of banks. Other European leaders worried that the rebelliousness might spread (Sarkozy cancelled a planned school reform, fearing “regicidal” mobs).
The teetering Greek prime minister, Kostas Karamanlis, sacked his finance minister, George Alogoskoufis, a month later and then loosened the public purse-strings ahead of an election. Greek bond yields had been drifting upward from the start of the credit crunch in 2007. But with the riots the spread over German bonds blew out, rising from about 160 to 300 basis points in late January 2009, after Standard & Poor’s had downgraded Greece’s debt. The European Commission placed Greece (and five others) under surveillance for breaching the 3% deficit limit. It said Greece and Ireland should step up deficit-cutting.
Senior French and German officials held secret meetings about how to respond should Greece lose access to bond markets.

In 1961, the Federal Reserve was concerned that banks have enough funds to prevent an economic slowdown then under way from getting worse. When interest rates rose in an overheating economy—or were raised by the Fed to forestall inflation—depositors put their money elsewhere because banks could not raise their own rates under Regulation Q. This diversion of funds was known as disintermediation, and the result was a credit crunch as bank lending to businesses would dry up.
Wriston realized that the Fed now feared disintermediation and the economy needed him as much as he needed the economy. But not all his competitors were in favor of the negotiable CD. Unlike Wriston, they feared challenging the Federal Reserve and were also concerned with a possible rate war, in which banks would keep raising rates competitively to attract depositors.

…

Now, with CDs, banks could more effectively compete. There were still restrictions on the rates paid, and the minimum size of a CD was $100,000, but bank credit increased far faster than the economy in these years, lending rising from $30 billion to $200 billion between 1962 and 1965.
By the mid-1960s, new negotiable CDs were not adequate to ward off likely disintermediation and resulting credit crunches. Spending on the Vietnam War was pushing the federal budget into deficit at a time when the economy was growing strongly, new social programs were under way, and U.S. business was booming. The negotiable CDs actually contributed to higher inflation and interest rates, a fact that was not well recognized by either policymakers or economists. Even as rates rose, “banks began to bid for funds aggressively,” wrote Salomon Brothers’ influential former economist Henry Kaufman, “driving open market rates to the maximum allowable under Regulation Q.”

Anyway, the middle-office risk manager will select the four or five most plausible stresses that could cause sudden $50 million losses to the firm. To the extent possible, the stresses should be independent rather than things likely to occur together. For a financial firm a typical set might be stock market crash, credit crunch, commodity price spike, interest rate spike, and liquidity squeeze. The risk manager works through plausible scenarios of how each stress would affect other markets, not just the stress itself but the likely follow-on effects. This considers only the immediate effects, not the future effects. For example, a credit crunch means there will be more defaults. But those won’t happen right away. The credit stress might begin with a major bankruptcy, but rather than guessing how many follow-on bankruptcies there will be, the risk manager estimates the effect of increased credit spreads on all the firm’s positions.

…

A financial professional’s instinct is always to do a spread trade. If she’s afraid credit is going to get worse, she buys protection on BBB-rated securities—these are the bonds just above junk bonds on the credit rating scale. Junk bonds can default in good times and bad, but a significant increase in BBB default rates tells you there’s a credit crunch. Of course, increases in default rates of higher-rated bonds—bonds with A, AA, or AAA ratings—tell you even more loudly that there’s a credit crunch. But the BBB spreads start to increase first, so it’s a good place to set your first line of hedging defense. If you start making money on your BBB hedge, you can use the profits to buy higher-rated protection.
The BBB protection is an insurance policy that pays off in severe credit downturns, but doesn’t pay any extra for historic downturns.

…

Its only risks now are that there might be some problem with the futures clearinghouse or some mismatch between the Treasuries it holds and the Treasuries deliverable under the futures contracts. Otherwise, it does not care if Treasury prices go up or down, or even if the U.S. government defaults.
We always knew there were some risks to this kind of leverage, but they seemed much smaller than the risks you eliminated by hedging. We learned that was not necessarily true. In a severe credit crunch and liquidity crisis, even good leverage, the kind that offsets your risks, could kill.
The next step is to think like a frequentist. What things did other people learn that were really just fluctuations in a random walk? U.S. Treasury bonds did great during the crisis, but that might not happen next time. A lot of people decided that illiquid investments were bad, without distinguishing carefully between the disaster of investments that were supposed to be liquid but weren’t versus investments everyone knew were illiquid all along.

., 18.
156 Mark Lynas, ‘Food Crisis: How the Rich Starved the World’, RedOrbit.Com, 22 April 2008.
157 As Mark Lynas points out in ‘Food Crisis’, in the 2007–8 period, the world population was growing by 78 million a year.
158 George Monbiot, ‘Credit Crunch? The Real Crisis is Global Hunger. And if You Care, Eat Less’, Guardian, 15 April 2008.
159 Lynas, ‘Food Crisis’.
160 In 2008, major food riots occurred in Egypt, Haiti (at least four people were killed in the southern city of Les Cayes), Cote d’Ivoire, Cameroon (at least 40 deaths), Mozambique (at least four people killed), Senegal, Mauritania, Bolivia, Indonesia, Mexico, India, Burkina Faso, and Uzbekistan. See Lynas, ‘Food Crisis’. It is important to stress that one of the consequences of urbanization is that people are removed from direct involvement in growing their own food and so rely on food markets instead. These are becoming increasingly global and are organized by major corporate and agribusiness. See Monbiot, ‘Credit Crunch?’.
161 Aditya Chakrabortty, ‘Secret Report: Biofuel Caused Food Crisis’, Guardian, 4 July 2008.
162 Ibid.
163 Julian Borger, ‘US Attacked at Food Summit over Biofuels’, Guardian, 4 June 2008.
164 Almuth Ernsting, ‘Biofuels or Biofools?’

…

The fusion of entertainment, media and war into what James Der Derian calls the ‘military-industrial-media-entertainment network’ has been centrally important here.135 ‘With the advent of the so-called war on terror’, wrote Andrew Ross in 2004, ‘the US government’s legitimacy no longer derives from its capacity or willingness to ensure a decent standard of living for those citizens; it depends, instead, on the degree to which they can be successfully persuaded they are on the verge of being terrorized.’136 Even amid the chaos and devastation of the credit crunch, desperate Republican campaign managers widely depicted the Democratic presidential candidate, Barack Obama, as a lurking ally of that ultimate terrorist foe, Osama bin Laden.
‘THE CITIES ARE THE PROBLEM’
The future of warfare lies in the streets, sewers, high-rise buildings, industrial parks, and the sprawl of houses, shacks, and shelters that form the broken cities of our world.137
Urban sites and urban military operations increasingly take centre-stage in all these new conceptualizations of war.

…

From a base of only 7 per cent of the US car market in 1997, SUVs started to outsell conventional automobiles in the US by 2002.10 ‘In 2003, SUV or “light truck” sales in the US hit an all-time high of 8,865,894 pickups, vans, and SUVs. That worked out to 53.2 per cent of all new-vehicle sales, another all-time high. In the first month of 2004, the 70 or more SUV models’ share of the market grew even more, to 54.6 per cent’ of the total market, we learn from an Air War College publication.11
SUV sales declined rapidly in 2007–8 as a result of the US credit crunch and the hike in oil prices. As a result, many car-makers, accustomed to the SUV’s profitability, were now struggling to survive. But the skyrocketing, and hugely profitable, US SUV sales, which exploited massive loop-holes in both emissions regulation and taxation, provides a dramatic parallel to the increasingly aggressive US military incursions in the Persian Gulf between 1991 and 2010. Exemplifying the links between US and other western cities and colonial frontiers, the design and marketing of SUVs grew increasingly militarized as the US military’s imperial wars proliferated.

In the eurozone, governments pledged in June 2012 to create a common banking supervisor, a responsibility that the ECB is finally due to assume in late 2014, albeit only for bigger banks, as will be discussed in Chapter 5. The hope is that the ECB will be more independent than national bank supervisors and more effective than the toothless EBA. Before the ECB takes on its new oversight role, it is due to conduct a review of the quality of banks’ assets. The EBA will follow through with what it promises will be rigorous stress tests.
Credit crunch
Meanwhile, zombie banks continue to drain life out of European economies. In Britain, banks’ outstanding loans to businesses fell by 5.4 per cent – £25 billion – in 2013.79 In the eurozone as a whole, bank credit to businesses fell by 3 per cent in 201380 – with a collapse of credit in southern Europe, notably Spain.81
When challenged, bankers typically claim that they would like to lend more, but that fewer borrowers want to borrow more.

…

It may be feasible for a tiny open economy to turn itself around in 2009–10 by slashing government spending and raising taxes because it could fill the gap through higher exports to its much larger trading partners whose economies happened to be buoyant at the time.227 But such a strategy can scarcely succeed for a continent-sized economy, especially when demand is weak in most of its major trading partners. To suggest otherwise is merely a version of the Alesina fallacy.
Counting the cost
How harmful has austerity been across the eurozone? It’s impossible to be sure, because the eurozone suffers from several problems and it is hard to disentangle, for instance, the depressing impact of austerity from the throttling effect of the credit crunch. For what it’s worth, the IMF calculates that in 2010–11 a fiscal squeeze of 1 per cent of GDP depressed the economy by between 0.9 per cent and 1.7 per cent.228 That is much more than in normal times, when it might shrink the economy by 0.5 per cent. Research by Jonathan Portes, formerly the head of the UK’s Government Economic Service and now director of the National Institute of Economic and Social Research, and his colleague Dawn Holland finds that the fiscal squeeze across the eurozone and Britain has been so harmful that it actually caused government debt to rise as a share of GDP.229 They reckon that the planned austerity in 2011–13 increased Greek government debt by more than 30 per cent of GDP!

…

Instead of stipulating that banks raise a specific sum of capital, they told them to hit a higher ratio of capital to assets. Since bank share prices were low and earnings meagre, banks opted to shrink their assets rather than raise additional capital. But since banks’ assets are primarily their loans to households and companies along with their government bond holdings, this led to a massive credit crunch and firesales of government bonds. By January 2012, EU leaders realised their mistake, but the damage was already done.287 Smaller businesses were hit hardest.288 Worse, policymakers were about to make an even bigger mistake.
Mistake five: threatening to force Greece out of the euro
What is there about international summits in France? The fifth huge policy mistake was the threat to force Greece out of the euro, initially made at the G20 summit in Cannes in early November 2011.

Anxious to display my superior knowledge of the darkest corners of the shadow banking system, I replied: ‘Credit-default swaps on super-senior tranches of asset-backed, security-collateralised debt obligations.’ I thought I had come up with a pretty pithy answer.
‘No,’ he gently chided me. ‘The most dangerous financial product in the world,’ he paused a moment for effect, ‘is the mortgage.’
The mortgage: from the Old French words mort and gage. Disputed translation: ‘death contract’.
Esther’s story
In the middle of the credit-crunch crisis of 2008 I met Esther Spick, then a single 34-year-old mum with two kids living in a maisonette in Surrey. It was the first home she’d owned, bought with an entirely inappropriate mortgage in 2005. She had been living on a council estate in Kingston, Surrey, working day and night to get a deposit to get a mortgage for her £235,000 maisonette. It had been sold – or mis-sold – to her during the boom by Northern Rock, and now the mortgage payments had rocketed by £500 per month.

…

In Colwyn Bay, at Property Park Mortgages, regulators found that an adviser called Darren Button had altered a payslip with Tipp-Ex. Mark Thorogood, also at Property Park, managed to record the income of a family member at £130,000, a convenient extra digit over the actual figure of £30,000.
A special prize must go to Mr Vigneswaran of Cherry Finance, Kingsbury, who was giving mortgage advice as an approved mortgage broker just as the credit crunch hit. The only thing was, he could not speak English. In fact, regulators discovered he knew little about Cherry Finance bar attending an opening ceremony. His son, already removed as an approved broker, had simply got the FSA to set his father up as a so-called ‘approved person’.
Spokespersons for the mortgage industry suggest that such practices (and there are hundreds of similar stories) are just the work of a few bad apples.

…

The rent nowhere near covers the mortgage and it’s got worse when the rates are so high now.’
Inside Track was an extreme example of the dark underbelly of the property market. But the rapid growth of the buy-to-let (BTL) market brings together all the elements fuelling house prices. For a start, BTL changed the British housing dream from owning your own property into owning other people’s property too. Many expected the credit crunch and recession to put paid to BTL. But the cult of the amateur landlord did not just return in the crisis. It prospered. Property values have held, rents have surged, and there have only been a piddling number of repossessions. After the new coalition government slashed planning red tape, mortgage volumes have ballooned. A year after the crash, the old names in BTL lending were back in the game.

Altered wording would have been seen as a signal that a rate cut was imminent, and Bernanke hadn’t maneuvered the committee to that point yet.
“Although the downside risks to growth have increased somewhat, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected,” the Fed said. (Translation: The odds of recession are growing, but we’re more worried that inflation will take off.) The statement implied that the Fed was shrugging off the unfolding credit crunch. There was no hint of Bernanke’s concern about the risks to the economy posed by disintegrating credit markets. So much for transparency.
“Sometimes the role of the release is more to placate nineteen people sitting around the Board table in Washington and less to educate the public,” said ex-Fed staffer Vincent Reinhart, who helped write the statements for six years.
The statement would quickly be overtaken by events — a reminder that behind the curtain at the Fed are a bunch of men and women, some smarter than others, trying to predict the course of an economy that stubbornly refuses to be predictable.

…

In contrast, in 2006, Bernanke’s impact was only double that of the next most influential speaker — and number two was attention-grabbing dissenter Bill Poole from St. Louis.
Mishkin, meanwhile, was putting on his own version of a full-court press. He knew that his advocacy of aggressive rate cuts alarmed hawkish bank presidents like Hoenig, but he had allies heading into the December FOMC meeting: Geithner was nearly always more worried than anyone else about the credit crunch. San Francisco’s Yellen and Boston’s Rosengren were also both inclined to cut rates another half-percentage point. The federal funds futures market was betting on a half-point cut as well. Most regional Fed bank presidents, though, used their discount-rate requests as a signal that they were leaning toward a one-quarter point cut. A couple of the hawks — Richard Fisher in Dallas and Tom Hoenig in Kansas City — didn’t want any rate cut at all.

…

Although not nearly as quotable and thus not as prominent as some other presidents, Rosengren emerged as a thoughtful, low-profile Bernanke ally during the Great Panic. He and the Richmond Fed’s Jeff Lacker had gone to the same New Jersey high school, although they didn’t know each other then, and were graduate students in economics at the same time at the University of Wisconsin. Rosengren began his Fed career in the Boston Fed’s research department, focusing for a time on the credit crunch and banking woes of New England in the 1990s as well as Japan’s banking crisis. In 2000, he moved into the nitty-gritty of bank supervision and regulation, an unusual move for a Ph.D. economist but one that gave him highly relevant expertise during the Great Panic and a clear view that some fellow bank presidents lacked. Where others saw signs of hope, Rosengren saw “a deteriorating housing sector, slowing consumer and business spending, high energy prices, and ill-functioning financial markets.”

But in what space does a revolutionary movement occur and how does it make space as it goes? That is the geographical question we now have to consider.
6
The Geography of It All
The crisis that began in highly localised housing markets in the United States in 2007 quickly spread around the world via a tightly networked financial and trading system that was supposed to spread risk rather than financial mayhem. As the effects of the credit crunch spread, it had differential impacts from one place to another. Everything depended on the degree to which local banks and other institutions like pension funds had invested in the toxic assets being peddled from the United States; the degree to which banks elsewhere had copied US practices and pursued high-risk investments; the dependency of local firms and state institutions (such as municipal governments) upon open lines of credit to roll over their debts; the impact of rapidly falling consumer demand in the US and elsewhere on export-led economies; the ups and downs in the demand for and prices of raw materials (oil in particular); and the different structures of employment and of social support (including flows of remittances) and social provision prevailing in this place rather than that.

ISDA had gathered in the same city two decades earlier, and Brickell considered that symbolically appropriate. Vienna was the home of the great free-market economist Friedrich von Hayek, Brickell’s hero. “[Twenty years ago] we set out to design a business guided by market discipline because we believed that it should be an even better guide to good behavior than regulatory proscription,” he observed. “The credit crunch gives good evidence that market discipline has guided the derivatives business better than regulation has steered housing finance.”
Brickell remained as opposed as ever to the idea that governments should intervene. “Hayek [the Viennese economist] believed that markets would create a rhythm of their own, that they are self-healing. That is something we all should remember and honor today,” he told the audience.

…

Policy makers were alarmed and confused about what was going on. More trouble seemed imminent.
One issue was that, as the problem came to be described, the tremors on Wall Street were now reverberating on Main Street. Banks buckling under their vast losses were slashing loans not just to hedge funds now, but to all sorts of companies. The crucial question now was one of timing: would the banks recover before the credit crunch threw the economy into recession? Solemnly, Paul Tucker, head of markets at the Bank of England, warned that “We face a race [against time]” to see whether “financial conditions…stabilise before macroeconomic slowdown, here and abroad, raises loan defaults.”
The signs didn’t look good for recovery at the banks that quickly; the losses just continued to mount. By April, the total loss in the estimated prices of mortgage-linked CDOs and other securities had reached almost $400 billion, a dramatically larger figure than any of the earlier predicted subprime losses, which prompted the International Monetary Fund to estimate that the total “losses” from the credit crisis could reach $1 trillion.

…

On Friday morning he called the club to say he was unsure if he would play. Six months after the drama of the Bear Stearns deal, he sensed that more trouble and uncertainty were about to strike. On September 7, the Federal Reserve had put the two state-backed mortgage giants, Fannie Mae and Freddie Mac, under “conservatorship,” a move tantamount to nationalization. By the summer, confidence that they would be able to weather the storm of mortgage defaults and the credit crunch had started to slip. The housing market was continuing to deteriorate fast, and the default rate on prime mortgages started to rise. Like the shadow banks and brokers, Fannie and Freddie had been operating with very high levels of assets relative to their equity.
The move on September 7 temporarily calmed markets, but it also stoked more uncertainty about long-term prospects. As the implications of the conservatorship sank in, many investors realized they had suffered big losses.

Chapter 8: Making the Transition
The transition from the current monetary system to the reformed system is made in two distinct stages: 1) an overnight switchover, when the new rules and processes governing money creation and bank lending take place, and 2) a longer transition period, of around 10-20 years, as the economy recovers from the ‘hangover’ of debt from the current monetary system. Changes are made to the balance sheets of the Bank of England and commercial banks, and additional measures are taken to ensure that banks have adequate funds to lend immediately after the switchover so that there is no risk of a temporary credit crunch (however unlikely). The changes can be made without altering the quantity of money in circulation.
The longer-term transition allows for a significant reduction in personal and household debt, as new money is injected into the economy and existing loan repayments to banks are recycled into the economy as debt-free money. The potential de-leveraging of the banking sector could be in excess of £1 trillion.

…

How the Money Creation Committee would work
Each month, the Money Creation Committee would meet and decide whether to increase, decrease, or hold constant the level of money in the economy. During their monthly meetings the MCC would decide upon two figures:
The amount of new money needed in order to maintain aggregate demand in line with the inflation target (similar to the setting of interest rates today), and;
The amount of new lending needed in order to avoid a credit crunch in the real economy and therefore a fall in output and employment (discussed in section 7.6).
Both figures would be determined, as is the case now when setting interest rates, by reference to appropriate macroeconomic data, including the Bank of England’s Credit Conditions Survey (a survey of business borrowing conditions, outlined in Box 7.C).
Once a conclusion had been made on the two figures mentioned above, then the Money Creation Committee would authorise the creation of a specific amount of new money.

…

Because banks would only be able to lend out money that had already been deposited in Investment Accounts, a lack of customers willing to invest (perhaps due to a negative outlook for the economy) would negatively affect a banks’ ability to lend, with potentially harmful effects on the economy.
The Credit Conditions Survey would help to forewarn the Bank of England if such a situation was imminent, giving it time to provide funding to banks (exclusively for lending to businesses) in order to avert a potential credit crunch.
In the longer term the Bank of England could also monitor the interest rate charged on loans to businesses. Generally speaking, a higher interest rate would suggest the need for the Bank of England to intervene to provide funding to the banks. However, there are several drawbacks to this approach. Firstly, a rising interest rate may signal either a fall in the supply of funds in Investment Accounts or a rise in the demand for loans.

There was a mad scramble to call in loans in order to comply. Seeing the danger, the authorities attempted to soften the edict by relaxing its terms and announcing a generous transitional period. But the measure came too late. The property market collapsed as mortgaged land was fire-sold to fund repayments. Mass bankruptcy threatened to engulf the financial system. With Rome in the grip of a credit crunch, the emperor was forced to implement a massive bailout. The Imperial treasury refinanced the overextended lenders with a 100-million sesterces programme of three-year, interest-free loans against security of deliberately overvalued real estate. To the Senate’s relief, it all ended happily: “Credit was thus restored, and gradually private lending resumed.”11
This first flowering of monetary society in Europe was not to last, however.

…

Readers rushed to consult the great financial historian, Charles Kindleberger.1 To learn of his discovery that “financial crises have tended to appear at roughly ten-year intervals for the last 400 years or so” was either disturbing or comforting, depending on one’s perspective.2 Within a couple of years, however, the economists Carmen Reinhart and Kenneth Rogoff had published an even more comprehensive investigation into the history of financial crises. Its ominous subtitle warned the reader to expect not just four but “Eight Centuries of Financial Folly.”3 And as Tactitus’ account of the credit crunch under the Emperor Tiberius shows, monetary society has been prone to the problem of growing indebtedness ending in a crisis of solvency for much longer even than that.
The reason is that this instability is intrinsic to money’s miraculous promise to combine security and freedom. The distinctive claim of money was that it could combine social stability and social mobility in a way that traditional society, with its immutable social structure, never could.

…

The acute phase of the crisis began to subside, and though the demand for sovereign money remained unusually high for months following the crisis, the focus shifted to counting the casualties in the post-Overends era. These were considerable. Three English and one Anglo-Indian bank had been forced into liquidation—at a time when there was no deposit insurance. Dozens of bill brokers and finance companies had gone under.
But as always, the real ramifications of the crisis were felt far beyond the medieval wards of the City of London and long after the acute panic had subsided. All over the country, the credit crunch resulting from the damage to confidence brought a severe contraction of business. More than a hundred and eighty bankruptcies were recorded in the three months following Black Friday.34 Unemployment rose from 2.6 per cent in 1866 to 6.3 per cent in 1867, and rose again in 1868 before a proper recovery took hold. Sectors that relied particularly heavily on credit, such as the global shipping industry operating from the wharfs of London’s East End, were especially badly affected: the annual report of the Poplar Hospital, a charitable institution for dockers, recorded that “there has never been a year so pregnant with disaster both public and private.”35 All in all, it had been the greatest financial crash since 1825—indeed, if only by virtue of the far more advanced development of the City and its international importance compared with that time, the greatest crash of all.

From the hype, you'd also think the U.S. was leaving its major rivals in the dust, but comparisons of per capita GDP growth rates don't bear this out. At the end of 1997, the U.S. was tied with France at second in the growth league, behind Canada, and just tenths of a point ahead of the major European countries. Step back a bit, and the U.S. sags badly. For the 1989-95 period, when the U.S. was stuck in a credit crunch and a sputtering recovery, it was at the bottom of the G7 growth league, along with Canada and the U.K. Between 1979 and 1988, there's no contest, with the U.S. tying France for the worst numbers in the G-7. Comparisons with the pre-crisis Asian tigers are hardly worth making.
It may be as capitalisms mature, financial surpluses break the bounds of regulated systems, and force an American-style loosening of the bonds.

…

This would require an extension of the central bank safety net to the entire financial matrix, not merely the commercial banks that were its legal charges. Fighting inflation might entail a terrible financial cost, and so the Fed would be forced to err on the side of indulgence whenever the credit system looked rocky.
Perhaps Minsky was a little early — the first financial crisis of the post-
WALL STREET
1945 period was the credit crunch of 1966 — but he described the mechanism perfectly: first the rising inflation of the 1960s and 1970s, followed by the Volcker clampdown, which was lifted when it looked like Mexico's default would bring the world banking system down. But the Volcker clampdown required driving interest rates far higher, and for a longer period of time, than anyone would have expected, to shut the economy down, so creative are the innovators at evading central bank restraints.

The dilemma of living in a Hamiltonian banking world without addressing the Jeffersonian nightmare of inequality has led to the current crisis of the unbanked.
But there is a Hamiltonian solution to Jeffersonian fears: a public option in banking—a central bank for the poor. The core function of the central bank, or Federal Reserve, is to infuse liquidity into troubled banks so that they can withstand a temporary credit crunch and get back on their feet. A public option would provide the same short-term credit help to individuals so that they, too, can withstand a personal credit crunch and get back on their feet. Indeed, in the modern banking landscape, only a large, liquid lender is able to lower the costs of lending to the poor.
Economies of scale and government backing can be used to bring down the costs of lending to the poor. The federal government is in a unique position to lend to the poor and cover its costs without having to answer to shareholder pressure to maximize profits.

…

Put simply, payday lenders, which consist of a handful of large corporations, get their loans from the largest commercial banks at low interest.7 These banks, of course, get most of their credit through customer deposits and the federal government. Even their use of our deposits, for which they pay virtually nothing, is made possible by an insurance scheme backed by the full faith and credit of the federal government.8 Banks also receive direct Federal Reserve money at a cool 1 percent interest, not to mention “discount window” loans, which help banks survive a credit crunch.9 When a bank, just like an individual, cannot pay its bills when they are due,10 the Federal Reserve gives the bank a short-term loan, so it can survive without having to sell off valuable assets. All this federal government support makes the banking sector unlike other businesses that must create their own wealth, without the use of other people’s money or cheap loans, when they fall short.

…

It takes money out of the economy by selling treasuries to banks, so they hold the government treasuries instead of all that cash.
The second lever, the discount rate, or the “discount window,” is used to allow banks to survive a “run,” or a large number of depositors demanding their money all at once. This liquidity, or cheap loans, from the federal government allows banks to remain in business amid a short-term credit crunch or a panic. The third lever permitting the Fed to affect the availability of credit is the reserve requirement it imposes on banks. Banks are required to keep a certain amount of money in reserve that they do not lend out. Banks use this reserve to operate and meet the withdrawal needs of their customers, while the Federal Reserve uses this reserve to achieve its own policy goals of either expanding or contracting the money supply.

pages: 436words: 114,278

Crude Volatility: The History and the Future of Boom-Bust Oil Prices
by
Robert McNally

., 2008.
Hamilton, James D. Causes and Consequences of the Oil Shock of 2007–2008. San Diego, Calif.: UC San Diego, Department of Economics, 2009.
Hammes, David, and Douglas Wills. Black Gold: The End of Bretton Woods and the Oil Price Shocks of the 1970s. Available at SSRN: http://ssrn.com/abstract=388283.
Harrington, Mark. “Oil Credit Crunch Could Be Worse than the Housing Crisis.” CNBC Commentary. January 14, 2016. http://www.cnbc.com/2016/01/14/oil-credit-crunch-could-be-worse-than-the-housing-crisis-commentary.html.
Harvey, Fiona. “World’s Climate Pledges Not Yet Enough to Avoid Dangerous Warming–UN.” Guardian, October 30, 2015. http://www.theguardian.com/environment/2015/oct/30/worlds-climate-pledges-likely-to-lead-to-less-than-3c-of-warming-un.
Heil, Emily. “Heard on the Hill: Bar Brawl.”

…

The collapse of the U.S. securities firm Bear Stearns in March 2008 intensified concerns about a financial crisis, and September brought more foreboding signs as Washington was forced to seize the government-sponsored housing lenders Fannie Mae and Freddie Mac.92 On September 14, 2008, the U.S. subprime mortgage crisis erupted into a global financial emergency when Lehman Brothers—the fourth-largest investment bank in the country—declared bankruptcy. Like many other financial institutions, Lehman held enormous amounts of low quality household debt securities. Its failure prompted contagion risk and a widespread collapse in market confidence. In October some $10 trillion of global equity value vaporized, in the largest monthly loss ever recorded.93 The world was quickly engulfed in a global credit crunch and economic growth screeched to a halt.
We know that consumers don’t quickly adjust their consumption of gasoline when oil prices change—but they do when their income changes. An employed worker has little choice but to pay whatever the pump price is to drive to work, but after losing his job, an unemployed person’s need to drive drops quickly. In 2008 incomes were collapsing and oil demand along with them, falling by 0.7 mb/d in 2008 and by 1.1 mb/d in 2009.94
As it became clear that the world was entering a massive recession, oil prices plummeted.

…

The Bank for International Settlements noted an “intense debate” about how falling oil prices would impact economies, flagging in particular the high debt burden of the oil and gas sector, which had grown by 250 percent from 2006 to 2015 and stood at roughly $2.5 trillion.99 Some worried that crashing oil prices could trigger a banking crisis and downturn as the Lehman crisis had spectacularly done six years earlier. “Oil credit crunch could be worse than the housing crisis,” blared one commentary headline on CNBC.100 Others noted that while the oil crisis was leading to losses at Wall Street banks that had lent producers sizable sums, comparisons with the mortgage crisis were overblown as the scale, complexity, and direct economic impacts were less severe in the case of shale oil debt.101
Whatever the true extent of the risk, crashing oil prices in January and early February 2016 exhibited a reminder that there is a downside to price busts, even for economies that ought to benefit from cheaper oil prices.

Review of Environmental Economics and Policy 2 (1) (Winter): 61-76.
Stevenson, Betsey, and Justin Wolfers. 2008a. Economic growth and subjective well-being: Reassessing the Easterlin paradox. Brookings Papers on Economic Activity 1: 1-87.
———.2008b. Happiness inequality in the United States. The Journal of Legal Studies 37 (s2) (June): S33-S79.
Stewart, Heather. 2009. This is how we let the credit crunch happen, ma’am . . . The Guardian, July 26. Available from http://www.guardian.co.uk/uk/2009/jul/26/monarchy-credit-crunch (accessed July 27, 2009).
Stiglitz, Joseph E., Amartya Sen, and Jean-Paul Fitoussi. 2009. Report by the commission on the measurement of economic performance and social progress. Available from www.stiglitz-sen-fitoussi.fr (accessed September 28, 2009).
Stutzer, Alois. 2003. The role of income aspirations in individual happiness.

…

Green businesses will provide only a limited number of jobs, especially right now.
If you’re lucky enough to land a good-paying job with a thriving green company, you may want to dive in headfirst. However, as we learned in the 1990s tech boom, there can be an ephemeral quality to a rapidly emerging sector, even for some of the highest-flying companies. In 2008 the surging renewable-energy sector ground to a halt, stymied by the credit crunch. And much of what’s passing as green today is sustainable in one, rather than all, of its dimensions. Hybrid vehicles emit less carbon, but their batteries are toxic. They’re better than BAU vehicles, but cannot yet be produced in large quantities without negative eco-impacts. So while they’re essential, today’s green products and technologies are not a magic bullet.
And if the broader economy does recover soon, and global expansion gets back on track?

While I chuckled at the time, it was interesting and scary how fast the world moves into panic mode, even without an obvious trigger like war, epidemics or natural disasters. This was a panic caused by the falling house of cards that most of us had helped build through the creation, purchase, regulation, complicity, or ignorance of a crazy, headless, expansion of credit. (I recommend How I Caused the Credit Crunch by Tetsuya Ishikawa (2009, Icon Books). Tets, who was very involved with crisis events while at Goldman and Morgan, has written a funny book about the financial crises.)
As bad as things were at the worst point of the 2008–09 crisis they could clearly have been much worse. There were still functioning financial markets, no governments had defaulted (they had in fact been able to oversee large and necessary bailouts), there was no hyperinflation or threats of war, and there was no widespread civil unrest.

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While recognizing that historical credit spreads overstate the expected return advantage, these spreads are a natural starting point for assessing corporates’ likely expected return advantage over governments. Figure 10.6 displays spread histories dating back to 1926 to show that Great Depression era spreads have still not been matched or exceeded even during the stagflationary recessions between 1973 and 1982 or during the 2008 Credit Crunch. I include a recession “dummy” variable (recessions are shaded) to highlight the strong countercyclicality in spreads. While Baa–Aaa and Aaa–Treasury spreads move together, lower rated bonds (as shown by the Baa–Aaa spread) exhibit more pronounced countercyclical variation than top-rated bonds.
Figure 10.6. Long-dated credit spreads since the 1920s.
Sources: Bloomberg, Moody’s, Ibbotson Associates (Morningstar), Federal Reserve Board, National Bureau of Economic Analysis.

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The average realized excess return of MBSs between 1990 and 2009 is 40% of the average OAS level (28 bp vs. 69 bp).
This realized performance is clearly disappointing. Some performance attribution gymnastics are needed to understand why. The downtrend in yields and unexpectedly efficient refinancings, some increase in volatilities, and a sharp widening of swap spreads and MBS spreads during the Credit Crunch have all contributed. Arora–Heike–Mattu propose a five-factor empirical model to explain the monthly excess returns on MBSs over Treasuries. The factors include realized and implied volatilities, swap–Treasury spread changes (a liquidity proxy), prepayment surprises, and spread directionality. All factors except prepayment risk should be hedgeable and there is unresolved debate whether prepayment model uncertainty (i.e., the possibility of model error) should be or is priced as a systematic risk factor.

…

The contrast between the empirical success of cross-country carry trading and lesser long-run profits in within-country carry trading—notably in credits or securitized debt—is striking. I consider the convenience of carry trading and the degree of systematic risk as alternative explanations:• One reason for the poor performance of credit carry is the headwind nature of the sample period (with some net widening of credit spreads between December 1992 and December 2009). Even if we study performance histories ending before the 2007–2008 Credit Crunch, however, long-run excess returns to credit carry are modest. I conjecture that corporate bonds have been the obvious easy way to chase yield, and as a result have tended to be structurally overpriced. Although the currency carry strategy did become overcrowded a few years ago, it was evident for a long time that less speculative capital was allocated to cross-country trading than to within-country opportunities

FHA Commissioner Philip Brownstein believed that “our innovations
and aggressive thrusts against blight and deterioration, our massive efforts on behalf of the needy, will be lost without an adequate continuing
supply of mortgage funds.”4
In a novel move, policymakers seeking a way to fund an expansion of
stabilizing home ownership in the cities turned to those same securities
markets for new sources of mortgage funds.5 Using markets as sources of
capital defined the Great Society approach. Rather than distributing existing mortgages through resale networks as New Deal–era institutions
did, markets would guarantee that credit crunches would not interrupt
urban development. With the mortgage-backed security, Great Society
policymakers tried to harness changes in capitalism to fit its programs
rather than trying to regulate capitalism to fit its agenda.
Beyond the immediate crisis of the Credit Crunch of 1966, the old
system of buying and selling individual government-insured mortgages
through personal connections had already begun to break down over the
1960s. The instruments and institutions through which Americans saved
had changed. Beginning in the late 1950s, the big growth in American
savings was through pension funds.

…

While in theory the mortgage-backed security allow borrowers to bypass financial institutions and borrow directly from capital markets, in
practice, a long chain of financial institutions still mediated the connection between borrower and lender, and it was the way in which the mortgage-backed security fit those institutional needs that made it such a success. Making the mortgage-backed security work required adjusting the
financial institutions that constituted the mortgage market—mortgage
companies, institutional investors, and the FNMA. The FNMA existed
before the credit crunch, but the Congressional response to the credit
crunch remade FNMA into a new kind of institution, even more privatized and market-oriented—with a new kind of financial instrument containing great possibilities. Created in the New Deal to buy and sell government-insured mortgages across the country, FNMA had forged a
national secondary market for mortgages offered through the FHA. During the 1960s, however, the federal government had created more and
more socially oriented, specialized housing programs that relaxed the
FHA’s lending requirements, especially in the inner city.

…

Toward that end, federal policy fashioned the financial innovation that made possible America’s debt explosion—the asset-backed security—that expanded well beyond its original purpose.
Solving the urban crisis would require solving the housing crisis. But to
fix the housing crisis, radical financial innovation would have to occur to
maintain the capital flows into mortgages. As the urban riots became the
urban crisis, however, mortgage markets had a crisis of their own. American mortgage markets had abruptly frozen—the so-called Credit Crunch
of 1966—as investors rapidly withdrew their deposits from banks and
put their money in the securities markets. Stocks and bonds offered
greater returns than the Federal Reserve–regulated rates available at
banks3 Without these deposits, banks could not lend mortgage money.
FHA Commissioner Philip Brownstein believed that “our innovations
and aggressive thrusts against blight and deterioration, our massive efforts on behalf of the needy, will be lost without an adequate continuing
supply of mortgage funds.”4
In a novel move, policymakers seeking a way to fund an expansion of
stabilizing home ownership in the cities turned to those same securities
markets for new sources of mortgage funds.5 Using markets as sources of
capital defined the Great Society approach.

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House of Cards: A Tale of Hubris and Wretched Excess on Wall Street
by
William D. Cohan

A few hours later, the Labor Department announced that some sixty-three thousand jobs had been lost in February, far more than had been expected. “Godot has arrived,” wrote Edward Yardeni, an economist and Pulitzer Prize—winning author who had been one of Wall Street's most relentlessly upbeat forecasters. “I've been rooting for the muddling through scenario. However, the credit crisis continues to worsen and has become a full-blown credit crunch, which is depressing the real economy.”
By March 7, the Carlyle hedge fund was hitting the wall, as more margin calls were pouring in and the fund could not meet them despite having a $150 million line of credit from the Carlyle Group in Washington. The fund's publicly traded shares were suspended. “Although the Company believed last week that it had sufficient liquidity, it was informed by its lenders this week that additional margin calls and increased collateral requirements would be significant and well in excess of the margin calls it received Wednesday,” John Stomber, the CEO, said in a statement.

…

By the time the Bear employees arrived at work the next day, some wag had already taped a $2 bill above the Bear Stearns logo on one of the revolving doors leading into 383 Madison Avenue. That image quickly became an apt metaphor for the brutal decline and fall of a once-proud firm, a firm that had survived every other crisis of the twentieth century, from the Depression to World War II to the market crash of 1987, without a single losing quarter but could not make it through the global credit crunch of 2007 and beyond. “Once you have a run on the bank, you are in a death spiral and your assets become worthless,” observed David Trone, a brokerage industry analyst at Fox-Pitt, Kelton. “Banks and brokerages are a house of cards built on the confidence of clients, creditors and counterparties. If you take chunks out of that confidence, things can go awry pretty quickly.”
On Monday morning, as “firefighters in kilts and St.

…

“If he doesn't like it, he should do his future business elsewhere,” Greenberg told Landon Thomas Jr. of the New York Times in an inflammatory article that appeared on May 7. It was the first time that either man had spoken publicly about the events that destroyed the company with which they were so closely identified.
Greenberg went on to blame Cayne for the demise of Bear Stearns. He said Cayne had not taken his advice as the credit crunch unfolded during the summer of 2007. “Jimmy was not interested in my point of view,” Greenberg said. “He was a one-man show—he didn't listen to anybody. That is when the real break took place.” When Thomas asked him to elaborate on specifically what he had recommended that Cayne do to alleviate the crisis at the firm, Greenberg said only, “You can read about it in my book.” He also criticized Cayne for bothering to still show up in his sixth-floor office.

pages: 1,242words: 317,903

The Man Who Knew: The Life and Times of Alan Greenspan
by
Sebastian Mallaby

The essence of the Ford presidency, Greenspan argued at a White House meeting on September 25, should be to reverse this self-reinforcing pattern of softheaded decisions.64
Other Ford advisers agreed in principle with Greenspan, but they worried that New York’s bankruptcy could trigger knock-on problems for the economy. Burns in particular predicted havoc. Banks were stuffed with New York bonds whose value would collapse, leaving banks too weak to lend; a credit crunch would follow. Even if the banks proved unexpectedly resilient, there were other possible channels of contagion. For one thing, a default in New York could destroy financial confidence in other American cities. Finding it hard to borrow, municipal governments would lay off police officers and teachers. As workers tightened their belts, business would fall off and the economy would spiral downward.65
It was not just Ford’s advisers who feared the consequences of Greenspan’s hard line.

…

With the White House and the Treasury likewise clamoring for lower interest rates, an uprising against Greenspan could not be ruled out. Volcker had been outvoted by his fellow governors at the Fed. Greenspan could not take dominance for granted.
A few days after Andrea set off with Cheney, on August 21, Greenspan presided over the next FOMC meeting. The case for cutting interest rates was in one sense stronger than ever: if the U.S. economy had been flailing under the impact of the credit crunch before Kuwait’s invasion, the outlook now was surely worsening. Rising oil prices would claim a growing share of Americans’ spending, leaving less demand for U.S. products; and geopolitical uncertainty would hurt bonds and stocks, raising the cost of capital to companies. Already a falling bond market had raised long-term borrowing costs by more than 50 basis points: Saddam Hussein had effectively tightened U.S. monetary policy without the Fed’s doing anything.7 But rather than supporting the economy and countering the Saddam effect by cutting short-term interest rates, Greenspan wanted to be tough.

Here he was, the head of fixed income, the only expert on the subject on the entire executive committee, and his recommendations to protect the firm were being resolutely ignored. Mike warned them of the coming credit crunch. He warned them of the lethal danger of that $15 trillion to $18 trillion of leverage out there, the credit derivatives issued between 2001 and 2007. It was a paper phantom that Lehman had done more than its fair share to create. At one meeting he pounded the table and shouted, “This is not going to be just a credit crunch. This is going to be the granddaddy of all credit crunches. And you’re trying to buy into a giant global asset bubble.” This took place in the middle of a Dick Fuld–inspired attempt to buy yet another inflated hedge fund. And again Mike voted no. He voted no—no—no, over and over.

…

There was no possibility of anyone securing a loan for anything, especially the investment banks. The short-term paper market ceased to exist. The safest, most solid banks in the world were unable to borrow money.
This was not just a difficult time, with banks stopping to catch their breath. This was a meltdown, and commerce in the United States was rapidly stalling. Hank Paulson was facing the beginning of the global credit crunch, the very same one Mike Gelband had warned him about on the telephone from Dick Fuld’s office seventeen months before.
Just then Hank was gazing with horror at one of those mysterious Wall Street insider’s charts known in the trade as the TED spread, a measure that perceived credit risk in the general economy. It’s the difference between the interest rates for three-month U.S. Treasury contracts—risk-free T-bills paying roughly 1.5 percent—and the interest banks charge each other for short-term loans, LIBOR, around 2 percent.

There he had been an enthusiast of Bush economic policies, including upper-bracket tax cuts, Social Security privatization, “securitization” of assets, and “safe” financial derivatives. No expert on exotic finance, he was an academic specialist in monetary policy—a man held out to Congress and the public as understanding how to prevent or ameliorate a great depression. The Fed, in Bernanke’s view, would have to expand the money supply or extend liquidity enough to overcome any credit crunch. As a card-carrying monetarist, he also insisted that no meaningful inflation was building in 2007 and early 2008 even though global commodity price indexes had begun to soar.
Thus, and without foresight, did a hapless George W. Bush assemble his last economic team. They would pick up where the original bubble-blower, Alan Greenspan, Fed Chairman between 1987 and early 2006, had left off. Together, the two would steer U.S. policy toward a blend of experimentation and panic—an outcome not unlike Hoover’s, albeit reached through new biases and myopia.

Morgan Stanley’s CEO, John Mack, told shareholders that the subprime crisis was in the eighth or ninth inning. Goldman Sachs’s CEO, Lloyd Blankfein, ventured the opinion that the markets were in the third quarter of the game. Dimon himself was optimistic that the credit crunch might be easing, but he was still disturbed by the weakening economy: “I told my investment banking friends, ‘Lucky for you, you’re probably through a big part of your pain. It’s continuing for some of us with real credit exposures to consumers.’”
Although Dimon was right on that last point, all three were wrong about the credit crunch. By the summer, Lehman and Merrill were fighting for their lives. Lehman Brothers got in a pitched public battle with the hedge fund manager David Einhorn, who aggressively shorted the company’s shares, convinced that its accounting couldn’t be trusted.

…

It wasn’t only Commercial Credit’s customer base that made its business markedly different from that of most banks. Whereas typical banks borrowed money over short periods and lent it over long ones—making them extremely vulnerable to rising interest rates—Commercial Credit lent over short periods while borrowing at long. The advantage of this model was that the company didn’t have to worry about a credit crunch. Its disadvantage was that if rates fell and Commercial Credit was already locked into long-term borrowings, it was vulnerable to being unable to reinvest those borrowings at their longterm cost of capital. In any event, it was a markedly different beast from a neighborhood branch banking business.
Not long after the issue of Fortune with Loomis’s article in it hit the newsstands, Weill received a call from Bob Volland, the treasurer at Commercial Credit.

…

The stock market itself had stabilized, but the world of high finance had a new, much more ominous problem on its hands. The availability of short-term credit had dried up overnight. When France’s biggest bank, BNP Paribas, halted withdrawals of three funds on August 8, because it couldn’t “fairly” value their holdings, panic set in. Despite a $130 billion injection of funds into the market on August 10 by the European Central Bank, a credit crunch had begun in which no one entrusted his money to anyone else anymore, and the normally fluid overnight lending markets evaporated. The Latin root of “credit” is credere, “to believe.” Belief had been obliterated.
What comes next is common to all historical financial panics. Individuals who act rationally (i.e., they try to sell, in order to protect their own interests) have an aggregate effect that is ultimately irrational (i.e., with all sellers and no buyers, assets that do have an inherent value are nevertheless deemed worthless).

All seemed to have the intensity of Olympic athletes about to compete. Optimism and confidence, born from being raised with nothing but making it big through their own sweat and grit, seemed to ooze from their pores. They knew they could overcome any challenges with enough hard work and patience.
To my left a number of the executives gathered to talk about joining forces to lobby the government more. They were worried about a credit crunch hitting small and medium enterprises, and they wanted to join together to present their case to the government to remedy the situation. Concerns about underground banks, loan sharks really, calling in loans was starting to become a topic of conversation.
Listening to the discussion, it was clear these were some of the savviest businessmen not just in China but in the world. I have advised chief executives of Fortune 500 firms and trailblazing entrepreneurs whose innovations change the world, but these Chinese entrepreneurs were as impressive as any executive or thinker I had ever met, and perhaps even more so, considering the filthy poverty and chaos they had grown up in just a few decades before.

More recently, the wild property and share speculation in Japan in the 1980s helped create the horrific pile of perhaps $1.5 trillion of bad loans in their banking system. Cheap money stimulated pointless over-investment, which has added to the woes. This reckless squandering has seen Japan’s economy steadily slither into virtual slump, record levels of unemployment, decimated share and property markets and a painful credit crunch.
Chancellor’s book quotes the extraordinary story of Mrs Onoue, a lowly Osaka restaurateur who in the midst of the bubble was allowed to borrow a total of $23 billion to buy shares. Reportedly her portfolio was controlled by a ceramic toad, which was said to receive trading tips from the gods. It was quite a draw at her restaurant.
One is constantly reminded that during periods of rapidly rising prosperity, people start behaving strangely and believing odd things.

…

In these circumstances, audit committee meetings are prolonged and tense because the auditors do not want to be sued if things go horribly wrong in six months, and no one wants to be prosecuted for misleading shareholders.
And, for the indebted, there are bank covenants – promises made to the bank in return for obtaining a loan. Covenants keep finance directors up at night. My contacts at the major lenders tell me many hundreds of corporate borrowers breached covenants in the credit crunch, especially in sectors such as retailing, construction and capital goods. But the banks cannot call in all their debts and appoint administrators – the wave of insolvencies would drown them. Instead, banks raise rates and charge big fees.
‘This is no time for ease and comfort. It is the time to dare and endure’
Winston Churchill
It becomes apparent that many leaders are really just suited to the good times.

pages: 182words: 53,802

The Production of Money: How to Break the Power of Banks
by
Ann Pettifor

Austerity and the collusion between politicians and the finance sector opened up political space for right-wing, populist political parties like Donald Trump and the Tea Party in the US, the National Front in France, and Golden Dawn in Greece. These were among the social and political consequences of democratic politicians enacting policies that enrich the few while impoverishing the majority; policies based on the interests of the robber barons and on the flawed theories of ‘defunct’ economists.
As this goes to press, almost nine years have passed since the ‘credit crunch’ of August 2007. Yet the global economy struggled to recover from that crisis and the easy (unregulated) credit-fuelled bubbles that were violently burst by rising real rates of interest. Instead of recovery, the crisis simply rolled around the global economy. It was at its most intense at the core – the US and the UK – but subsequently moved across to Europe and in particular the Eurozone. Then the crisis moved to emerging markets, and China in particular.

…

CHAPTER 5
Class Interests and the Moulding of
Schools of Economic Thought
Economic fundamentals are all sound; it’s a good time for tighter credit conditions … the recent sell-off in financial markets is good news … The world economy is strong enough to cope with the consequences.
The Economist, 4–10 August 2007
Editors and journalists at the Economist magazine were not the only professional economists to make entirely the wrong call in the week that inter-bank credit ‘crunched’ and the 2007–09 global financial crisis began in earnest.1 Most academic economists shared their blind spot for the likely impact of financial deregulation on the financial system, the global economy and societies around the world.
A great deal of the power exercised by financiers operating in financial markets derives from the studied indifference of orthodox academic economists to the production of money and the social construct that is the rate of interest on money.

As I am presenting this speech, I find myself giving this huge rant about how I believed there was going
to be a global credit crunch. I said, “Asking people in the credit market how they feel is like asking someone who has jumped out of the 50th
floor window how he feels as he passes floor 10. He is currently all right, but he is not going to be soon.” I heard myself coming out with this
stream of consciousness.
You didn’t plan this talk?
I never plan talks. I went on and on about how the credit markets are ready to implode. There are about 200 people in the room. When I
finished, there was dead silence. They really thought I had gone off the deep end.
What did you predict was going to happen?
I said there was going to be a total credit crunch, an equity market meltdown, and a flight to quality bonds.
Had you adjusted your portfolio to reflect these expectations?

…

Had you adjusted your portfolio to reflect these expectations?
No, it just dawned on me as I was giving the speech. I went back to the office and thought, $9 billion of stocks going into a credit crunch; I
don’t want any of this crap. I got the fund manager into my office and said, “Look, August was not that great.” The strategy was down about 5
percent in August. I continued, “Honestly, I don’t believe in this anymore. There’s going to be a credit crunch, and the stuff you’ve got is going to
be absolutely toxic. Let’s shut the strategy down.”
Even though it was market neutral?
Yes, because I was afraid of a lack of liquidity.
Actually, August 2007 was the month when many statistical arbitrage and some market neutral funds got killed. A 5 percent loss for a
market neutral fund that month is not really that extreme.

…

One thing that brings my blood to a boiling point is when an absolute return guy starts
talking about his return relative to anything. My response was, “You are not relative to anything, my friend. You can’t be in the relative game just
when it suits you and in the absolute game just when it suits you. You are in the absolute return game, and the fact that you use the word relative
means that I don’t want you anymore.”
What made you so convinced of an impending credit crunch?
It was just the huge excess leverage in the system everywhere you looked, and when LIBOR jumped by 10 basis points, it was like seeing the
first crack.
What happened to LIBOR liquidity after that point?
It went straight down. The LIBOR–OIS spread started to widen.
What is the OIS?
The OIS is the overnight index swap, which is a weighted average of overnight lending rates. The LIBOR-OIS spread reflects the illiquidity
premium.

Marx’s prediction was also given a leading role in a best-selling account of the subprime crisis, The Storm, whose author (Vince Cable) subsequently became (as Business Secretary) a member of the Coalition Government in the United Kingdom (Cable 2009: 8). The quotation was a fake.4
Marx’s presence in this crisis has been compelling.5 Had he really told us so, as the placard proclaimed? Did his arguments capture the underlying causes of the credit crunch? Could a theory of money based on his work—formulated in the nineteenth century—really help to explain the global imbalances that fueled the subprime crisis, as well as the various other crises (e.g., the crisis in the Eurozone) that followed? Three and a half years after the Lehman bankruptcy, the Financial Times ran a series of articles under the heading “Capitalism in Crisis.” The first article picked out “greedy bankers, overpaid executives, anaemic growth, stubbornly high unemployment” as key factors driving the Occupy protests and causing “the wider public in the developed world to become disgruntled about capitalism,” which is “widely perceived to be failing to deliver” (Plender 2012).

…

Third, hoarding creates the need for credit money, as well as for fiat money, as alternative means of circulation to real money (or hard cash). Fourth, credit money creates the illusion that capital is self-expanding and leads to the formation of fictitious capital. Fifth, the existence of fictitious capital makes the cycle of speculative bubbles and crashes an inevitable feature of capitalism. Sixth, a credit crunch always follows from the formation of a speculative bubble, creating a sudden demand for real money, or hard cash.
When reading through these steps, it is not difficult to see how one could imagine Marx saying, “I told you so.” In the 2007–8 crisis, we saw a sudden credit depreciation trigger a flight from risk, whereby investors sought to offload financial instruments in a rush for the safe haven of money, or at the very least, the higher rated sovereign bonds, such as U.S.

County and city governments are having similar problems, and we’re likely to see the largest municipal bankruptcy in American history very soon, in the county in Alabama where Birmingham is, which will I think be about twice the size of the Orange County bankruptcy of about 10 years ago. So this is having real world effects. And when governments can’t borrow they have to cut services and lay people off. So this is very, very real stuff here.
Now this is a credit crunch, so it’s not about the price of credit, the interest rate, but the availability of it. I’ve heard several responses to this, and let me just deal with a couple of them.
I’ve heard several people say it’s a hoax. No, it’s not: the credit freeze is not like WMDs in Iraq, it’s visible in real stats that are quoted daily, weekly, or even quoted in real time in Bloomberg terminals around the world.

…

The Obama team is compelled to engage.
Nonetheless, it is an ambitious deadline. It took nearly two years of discussion before there was sufficient agreement to attempt the 1944 Bretton Woods Conference in New Hampshire that famously established the post-war international financial system and to which the current summit process is being compared. But shared awareness that the system is broken and that the world risks a credit-crunch-induced global depression is concentrating minds wonderfully.
Where to start? The architects of Bretton Woods I knew they had to avoid the beggar-my-neighbor policies of the 1930s—economic autarchy and hyper-militarization—and that if the U.S. and Britain could clinch a deal, then everybody else would have to follow. Even then it was a struggle. The question then, as now, is how much are governments prepared to pool economic sovereignty and accept fiscal disciplines in order to produce the greater global public good?

Congress set up a bail-out agency, the Resolution Trust Corporation (RTC), in 1989, to assume title to the hundreds
of billions of dollars of real estate assets and bad loans from failed S&Ls
and banks.
The lending ban on the industry severely limited construction in the
country. The Urban Land Institute, a leading real estate think tank, set
up the Credit Crunch Task Force to work with the Federal Reserve to lift
the ban.
The reaction of the Federal Reserve to the Credit Crunch Task Force,
according to Bob Larson, a senior executive with the Wall Street investment banking firm of Lazard Feres & Company, and a member of the task
force, was “the Fed told us ‘real estate . . . we know the industry is huge
but we know very little about it. Put together some economic information
about its impact on the economy.’” The Fed was aware neither of the actual
size of the real estate industry nor the importance of the industry to the
economy—an amazing but true admission.

All a bank needed was highly skilled (or lucky) traders. No pesky
customers were needed for deposits—you simply bought OPM in the
interbank market. The benchmark rate became know as LIBOR—the
London Interbank Offered Rate—and remains the most important
single interest rate in the financial world. This is why, when LIBOR
went through the roof in August 2007, it was the canary in the mineshaft signaling the start of a global credit crunch that morphed into a
full-fledged crisis: Interbank lending had seized up because banks
The Natural History of Financial Folly
wouldn’t trust each other with even short-term placements. This was
a shock from which the system only recovered slowly and tentatively.
DANGEROUS CUSTOMERS
The third source of danger for bankers gone wild was keeping bad
company. Governments or government enterprises from the very beginning of the Euromarkets were vastly more important than other
borrowers.

…

The industry lost over $45 billion in just 3 years between 1985 and
l987. Between 1980 and 1992, a total of 1,142 savings and loan associations and 1,395 banks were closed, and many others were forced to
merge. States as large as Texas effectively had their entire indigenous
banking system fail and fall into out-of-state control. Bailouts cost
the Treasury hundreds of billions, and a severe credit crunch and collapse in real estate values helped trigger and extend a recession in
1990 to 1992.
CAPITAL MARKETS TAKE OVER
The same decade that saw the banking industry enter its perfect storm
saw the beginning of the longest bull market in Wall Street history.
The 25-year bull market that ended in 2008 coincides with a vast
increase in pension fund assets under professional management.
Some of this merely reflects demography as the Baby Boomers began
to accumulate wealth.

MG Rover engineers, production managers,
and technical staff were also hired to help improve production and
strengthen their design and innovation capabilities.
The China Development Bank (CDB) and Temesek Holdings from
Singapore, both state-owned corporations, bought into Barclays Capital, originally to support its takeover bid for the Dutch investment
bank ABN AMRO. Luckily for them, the bid failed and Royal Bank
of Scotland struck a deal with ABN AMRO and subsequently lost 96
percent of its share value following the credit crunch. In our interviews
with some of the leading players and commentators in this bid, it is
clear that the China Development Bank had linked up with Temesek
because it had far wider experience in this area and because of the
learning and experience that the CDB would acquire with positions on
the board of Barclays.
There has also been increasing use of state “sovereign funds” that
have enabled countries including China, Russia, Singapore, and the
Arab states to accumulate large reserves of U.S. dollars, giving them
the ﬁnancial resources to buy into overseas companies.

…

Likewise, human capital assumptions about the returns to knowledge workers rest on an
outdated understanding of the global economy, as the proportion of
wealth creation accruing to the workforce rather than shareholders
has declined. Global sourcing can be used to play off different groups
110
The Global Auction
of knowledge professionals scattered around the globe whether within
the same or different organizations.
Stephen Roach, chief economist at Morgan Stanley, reported that
the win-win scenario for globalization was in serious trouble well
before the credit crunch. While he believed that some workers in the
developing world were beneﬁting from global trade agreements, this
was not the case for many workers in the rich developed world, as most
of the beneﬁts had accrued to owners of capital at the expense of labor.
He observed a powerful asymmetry in the impact of globalization on
the world’s major industrial economies that led to record highs in the
returns accruing to capital and record lows in the rewards going to
labor.

World Cancer Research Fund receives no government funding for its scientific
research programmes, so this vital work is only made possible through the
generosity of individual donations, with legacies being a very important means
of support. Leaving a gift in your will to us would help ensure less people are
affected by this terrible disease and what better legacy to leave to your loved
ones – a future free from cancer.
Your legacy could help stop
cancer before it starts.
advertisement feature
Why Do You Need a Will? ■ 15
The wealth of this nation has dramatically increased over the
past 15 years despite the current credit crunch. It is not just the
privileged few who have money and assets to leave to their
family and friends. The increase in house prices was one of the
most significant adjustments to personal wealth in the early to
mid 2000s. In addition, increasing numbers of the second generation are inheriting a property or indeed have purchased a
second home. And a few may own yet another property in this
country or overseas, which may be rented out.

…

Certainly, a valuation of the business as at
the date of death is needed and the business’s accountants will
need to be involved.
In the case of intestacy, as an administrator you might need a
solicitor if complications arise, such as difficulties in tracing
missing relatives or living relatives residing overseas. This
problem is a fairly common one and solicitors know the many
ways to have relatives traced.
136
Time to update your will
A knock on effect of the credit crunch is that
wills written in healthier economic times are
going out of date and thousands could be in
urgent need of updating.
Making a will
is particularly
important if you
are not married to
your partner but
are cohabiting.
With home values plummeting and other investments
struggling, many assets in a person’s will have lost value.
Those wanting to leave friends and family in a secure
position after they pass away might ﬁnd that what they
have left in their will has considerably less value than when
their solicitor wrote it.

A post-crash genre of books had sprung up with titles promising drugs, sex and extravagantly bad behaviour: Binge Trading: The Real Inside Story of Cash, Cocaine and Corruption in the City; Gross Misconduct: My Year of Excess in the City; Confessions of a City Girl: The Devil Wears Pinstripes. Barbara Stcherbatcheff’s story starts in a strip club, which also occupies significant sections of Tetsuya Ishikawa’s How I Caused the Credit Crunch: A Vivid and Personal Account of Banking Excess. The best known of those books is Cityboy: Beer and Loathing in the Square Mile by Geraint Anderson. In this semi-fictional autobiography, he spends 200 pages drinking, snorting coke, ogling strippers, chasing whores and, above all, complaining about hangovers. It is an entertaining read. It was also immensely lucrative for its author – according to Anderson, Cityboy has sold a quarter of a million copies.

Haldane avoided putting a specific timescale on this, and also avoided saying what would happen after that undisclosed period.
Martin Wolf
As the main financial columnist and associate editor at the Financial Times, Martin Wolf is the very epitome of a City establishment figure. He was described by US Treasury Secretary Larry Summers as “probably the most deeply thoughtful and professionally informed economic journalist in the world.”[xlvii] Although the credit crunch and subsequent recession have re-kindled his youthful enthusiasm for Keynesian economics, it is still a surprise to read him advocating income redistribution and universal basic income, as he did in this article from February 2014:
“If Mr Frey and Prof Osborne [see below] are right [about automation]… we will need to redistribute income and wealth. Such redistribution could take the form of a basic income for every adult, together with funding of education and training at any stage in a person’s life. ...

…

[xxxii] http://fortune.com/2015/11/10/us-unemployment-rate-economy/
[xxxiii] This and the other quotes in this paragraph and the next one are from Chapter 10: Toward a New Economic Paradigm.
[xxxiv] Brynjolfsson is the director of the MIT Center for Digital Business and McAfee is a principal research scientist there.
[xxxv] The word “inequality” crops up 42 times in the book, including in the titles of sources, but the authors never explicitly connect it with “spread”.
[xxxvi] The loosely-organised protest organisation that sprang up after the 2008 credit crunch to campaign against inequality.
[xxxvii] Chapter 12: Learning to Race with the Machines: Recommendations for Individuals.
[xxxviii]
Chapter 13: Policy Recommendations.
[xxxix] Chapter 14: Long-Term Recommendations.
[xl] http://www.susskind.com/
[xli] http://www.scottsantens.com/
[xlii]
https://www.reddit.com/r/BasicIncome/ and https://www.reddit.com/r/basicincome/wiki/index
[xliii] https://www.youtube.com/watch?

The Fix: How Bankers Lied, Cheated and Colluded to Rig the World's Most Important Number (Bloomberg)
by
Liam Vaughan,
Gavin Finch

That afternoon Stephen Green, HSBC’s chairman and an ordained clergyman, presented the paper on the opening day of the BBA’s annual conference to some 350 bankers and finance professionals who had gathered
among the marble columns and crystal chandeliers of the 19th-century
Gibson Hall. It read:
Since its inception in 1985, BBA Libor has enjoyed a reputation
for accuracy. However, just as the credit crunch has led to stress
in the markets, and the breakdown of longstanding correlations
in the pricing of assets, as a barometer of these markets, it has
also been stressed. This has led to discussion of some of the BBA
Libor currency fixes—particularly the dollar fix—within the financial
community. This proper discussion has overflowed into commentary
No One’s Clean-Clean
59
in the media, and the BBA believes that it needs to correct a number
of misunderstandings and misperceptions.

The Cuban-born de Molina, who was respected in the financial community, rubbed Alphin the wrong way from the start by referring to his HR shadow as a member of the “Gestapo” or “Stasi.” De Molina refused to read the talking points handed to him by HR for his meetings and goaded Alphin into doing something about it. But de Molina had a fiery temper, and after a blowup with Alphin, he lost support among his colleagues on the management committee. In December 2006, just as the credit crunch was about to begin, he quit.
During 2007, Taylor continued to excel as Mr. Outside at BofA’s investment bank in New York, but without any Mr. Inside managing the firm’s risk, or monitoring its trading positions, BofA Securities made some bad bets, including buying into a pair of Bear Stearns hedge funds constructed around CDOs.
On Thursday, October 18, just a few weeks after Ken Lewis met with Stan O’Neal to talk about the possible purchase of Merrill Lynch, Bank of America announced a 31 percent decline in its third-quarter earnings, largely due to $3.7 billion in write-downs of assets acquired by its investment banking operations in New York.

…

The only question is whether an investor thinks the value of a security has hit bottom, and is about to turn upwards, or whether the asset is still overpriced.
In the 1990s, gutsy investors who purchased the remains of failed savings and loans reaped financial windfalls when the U.S. banking industry bounced back to robust health. That lesson was not lost on the market in 2008. It was just that the severity of the credit crunch and the collapse of Bear Stearns suggested that this downdraft might be more severe than others in recent memory.
Traders and investors are always on the lookout for bargains in the financial markets. They’re also wary of trying to “catch a falling knife” and miscalculating on when a stock or other type of asset will turn around.
CHAPTER 9
TERMINATED WITH PREJUDICE
AT BANK OF AMERICA, Brian Moynihan embodied all the attributes of the old NCNB culture: He was completely dedicated to the Charlotte bank, a tireless worker, and he executed every order he received from on high.

…

It was the same seat O’Neal had taken the previous October, when he issued his ultimatum to the directors, that if they didn’t trust his judgment on pursuing a deal with Wachovia, he didn’t want the job anymore.
Having finished the previous item of business, Thain moved on to the seventh item on the board’s agenda that day, saying that Wetzel, head of strategy, would provide the board with an overview of the investment banking landscape, particularly in light of the credit crunch. Thain then directed the board members to look at the blue spiral books that had been handed to them, so they could follow Wetzel’s presentation more closely.
The forty-eight-year-old executive, a native of Buffalo, began talking about how the banking world had changed in the past twelve months. Financial behemoths that were setting records for profits in 2005 and 2006 began crashing to earth at the end of 2007.

A front-page headline from the January 31, 1990, New York Times read: “Recession Chances Have Diminished, Greenspan Says.”33 In August of 1990, he pronounced, “ ‘those who argue that we are already in a recession are reasonably certain to be wrong.’”34 The recession’s official starting date was July 1, 1990.35 Greenspan never mentioned the existence of a recession until four years later.
In 1994, Alan Greenspan produced a history lesson that served the interests of Alan Greenspan. He spoke of a credit crunch in the spring of 1989. The Federal Reserve chairman had anticipated the problem: “In an endeavor to defuse these financial strains, we moved short-term rates lower in a long series of steps in the summer of 1992, and we held them at unusually low levels until the end of 1993—both absolutely, and, importantly, relative to inflation.”36
Greenspan’s reconstruction of his own actions grew more heroic: “Lower interest rates fostered a dramatic improvement in the financial condition of borrowers and lenders.

…

Beckner, Back from the Brink: The Greenspan Years (New York: John Wiley & Sons, 1996), p. 215.
3 James Grant, The Trouble with Prosperity: The Loss of Fear, the Rise of Speculation, and the Risk to American Savings (New York: Times Books, 1996), p. 192.
4 Beckner, Back from the Brink, p. 245. In early 1991, Greenspan told the Senate Banking Committee that the Fed had seriously considered buying commercial bank loans to ease the credit crunch. The looming question, Greenspan explained, was whether the Fed should become “effectively a commercial banker.” Ibid., p. 226.
5 Ibid., p. 432: “Bush made what is known as a recess appointment while Congress was not in session. Greenspan’s term as chairman expired on August 11, 1991, and his term as governor on January 31, 1992. Announced August 9, the recess appointment took effect August 10.

…

In London, he told the Daily Telegraph that “Britain is more exposed than we are [to mortgage defaults]—in the sense that you have a good deal more adjustable-rate mortgages.”17 That would seem to contradict his variable-rate advice in February 2004, when he advised Americans to look overseas, “where adjustable-rate mortgages are far more common.”18 His statement to the Telegraph was on September 17, in the midst of a bank run on Northern Rock, a British bank. He may not have heightened the hysteria sweeping Britain, but he could have kept his mouth shut.
14 Interview with Leslie Stahl, 60 Minutes, September 16, 2007.
15 Jane Wardell, “Greenspan Defends Subprime,” Associated Press, October 2, 2007.
16“World Markets Still Affected by Fear: Greenspan,” Le Figaro, September 23, 2007.
17“UK More Vulnerable than America to the Credit Crunch, Greenspan says,” Daily Te l eg raph (London), September 18, 2007.
After Britain, he was seen in Vienna, where he said, “[T]here is no doubt about the fact that low interest rates for longterm government bonds have caused the real estate bubble in the US” and “[real estate] prices are going to fall much lower yet.”19 In Amsterdam, Greenspan fueled a cabinet crisis (about unemployment) when he told the press and ING Bank’s guests that the unemployment numbers are so low in the United States because it’s easy to fire an employee and it’s also easy to find a job. 20
The author grew more defensive.

Figure 1.2: The US federal deficit, 1990–2012
Source: Congressional Budget Office. Data for 2011 and 2012 represent CBO projections.
In the George W. Bush years, things got worse. The federal government became habituated to borrowing. Taxes never covered spending‌—‌but still, even in 2004, the worst of those years, federal borrowing never breached the $500 billion level. And just as well: $500 billion is a lot of money.
Then came the credit crunch. Lehman, AIG, General Motors‌—‌the first, most colorful phase of the current credit crisis. In 2008, the deficit hovered close to $500 billion. The following year, it was approaching $1,500 billion, or $1.5 trillion if you prefer.
Just pause for a moment to consider how much money that is. Numbers that large become difficult to comprehend, because of the absence of obvious comparisons. So let’s look at some big numbers.

…

We’re about to start examining the scale of possible losses still to come in the current credit crisis; but before we do so, I need to make a couple of important points. They cut two ways. First, it is not only the banking system which holds poor-quality assets. Many of those assets will have ended up with insurance companies, pension funds, and central banks, for example. In the 2008–9 phase of the credit crunch, about two-thirds of the total losses ended up being absorbed by the banking system, and about a third by insurance companies and other investors.4 In the absence of a better guess, I’d say that the same division of probable losses to come still holds true.
That first point is helpful. Systemic risks stem largely from the banking sector, so if losses are shared more widely, the banking sector is that little bit more robust.

…

For the first quarter of 2011‌—‌and bear in mind that only twenty-seven banks were involved in this study‌—‌the total of nonperforming loans was some $200 billion as compared with the reported total of $129 billion.12 That’s potentially as much as $70 billion smuggled away in games of extend and pretend.
Misrepresentation on that scale is somewhat alarming, to put it mildly. On the other hand, in the context of the figures we’ve been looking at so far, $70 billion sounds manageable. But don’t be fooled. The IMF estimated the total losses arising from the first phase (2007–10) of the credit crunch (more on this at the end of the chapter). Excluding sovereign losses (which didn’t play a part in that phase) and residential mortgages (which we’ve already covered), the IMF estimated that losses in the corporate and other consumer sectors amounted to approximately $2.2 trillion, of which about $1.4 trillion ended up pounding bank balance sheets. If there is a new global recession unfolding now, or soon, I’d expect it to be more severe than last time, simply because the effects of the previous collapse were cushioned so heavily by governments borrowing and printing money.

But the process is not as bizarre as one might think and the way that the English language has travelled and changed through time and space throws up many examples of contemporary craziness.
‘Globalization’ is a word that first slipped into its current usage during the 1960s; and the globalization of English, and English literature, law, money and values, is the cultural revolution of my generation, before and after the ‘credit crunch’. Combined with the biggest IT innovations since Gutenberg, it continues to inspire the most comprehensive transformation of our society in five hundred, even a thousand years. This is a story I have followed, and contributed to, in a modest way, ever since I wrote the BBC and PBS television series The Story of English, with William Cran and Robert MacNeil, in the early 1980s. When Bill Gates was still an obscure Seattle software nerd, and the latest cool invention to transform international telephone lines was the fax, we believed we were providing a snapshot of the English language at the peak of its power and influence, a reflection of the Anglo-American hegemony.

…

For these aspiring millions, it will be Globish that offers a way forward.
As we enter the second decade of the new century, we are witnessing, in Globish, a contemporary phenomenon of extraordinary range and complexity, expressing a new world of global interconnections. When I was completing the first draft of this book in October 2008 I would break off from the day’s work to watch the television news. These were momentous hours, as the ‘credit crunch’ swiftly became the ‘global financial crisis’. Hour after hour, there were reports of falling markets in Japan, Hong Kong, Singapore, Frankfurt, Paris, Milan, London and New York. Across a dozen different time zones, financial journalists in each of these cities filed reports for their national desks, but the language of the crisis was unvaryingly Globish. European finance ministers held urgent press conferences, addressing the world’s media in Globish.

Doing so risks creating credit, housing, and stock market bubbles in China, much as in the United States. With little freedom to use interest rates to counteract such trends, the Chinese authorities have to use blunt tools: for example, when credit starts growing strongly, the word goes out from the Chinese bank regulator that the banks should cut back on issuing credit. Typically, private firms without strong connections bear the brunt of these credit crunches. Chinese industry goes from credit feast to credit famine, which disrupts long-range planning.
The low interest rate has other adverse effects: it reduces household income and, somewhat perversely, may force households to save more in order to build a sufficient nest egg for retirement.11 It thus depresses household consumption and makes China yet more dependent on foreign final demand. More problematic, it keeps the cost of capital unnaturally low.

Fisher saw his proposal also as a contribution to making government
more independent from banker’s inﬂuence. He wrote that in hard times,
banks become creditors of the government and exert an “unhealthy
inﬂuence” on politics. Reclaiming their superiority in issuing money
would somewhat shield governments from this, he argued. In a similar
way, banks’ power over other companies would be reduced if creditdriven booms and busts were mitigated. During credit crunches and
because of the threat of credit crunches, banks can demand a lot of
inﬂuence over companies in exchange for helping them to survive
(Fisher 1996/2009).
Chances are slim that contemporary students of economics will think
about any of that. The leading textbooks in economics, for instance
Mankiw and Taylor (2006), restrict the discussion of the monetary
system to explaining the process of private money creation in a rather
roundabout way, and as if it was a law of nature.

Knowledge services now account for more than two thirds of what Britain sells to the world. With low-skilled jobs disappearing and knowledge jobs expanding, it is obvious that the UK needs to invest in knowledge, to educate and train its workforce. Britain has a higher proportion of NEETs – young people not in education, employment or training – than any other OECD country except Greece, Italy, Mexico and Turkey.
The credit crunch only served to magnify the point. Unemployment figures in the depths of the recession showed that among those working in the knowledge economy – financial consultants, business managers, lawyers – the proportion claiming jobseeker’s allowance was 1 per cent. Among those who usually worked in unskilled admin jobs, the figure was 37 per cent. And for those without skills, matters are only going to get worse.

We hope the ideas set out in this book show that there is nothing inevitable about this failure. A more innovative, sustainable and inclusive economic system is possible. But it will require fundamental changes in our understanding of how capitalism works, and how public policy can help create and shape a different economic future.
Notes
1 http://www.telegraph.co.uk/news/uknews/theroyalfamily/3386353/The-Queen-asks-why-no-one-saw-the-credit-crunch-coming.html (accessed 12 April 2016).
2 Following the Queen’s question, the British Academy held a seminar to enquire into how it should be answered, and subsequently wrote to the sovereign to explain their conclusions. See http://www.britac.ac.uk/news/newsrelease-economy.cfm (accessed 12 April 2016).
3 S. Verick and I. Iyanatul, The Great Recession of 2008–2009: Causes, Consequences and Policy Responses, Discussion Paper No 4934, Bonn, Institute for the Study of Labor, 2010.
4 IMF, World Economic Outlook: Uneven Growth—Short- and Long-Term Factors, Washington, DC, International Monetary Fund, April 2015, p. 171.

…

At the same time, instead of pretending it can be a hard science, it needs to develop qualitative thinking and engage in ‘appreciative theorising’35 to enrich its quantitative methods and bring them closer to the changing social reality. It is interesting to note that practically all the macroeconomic tools and concepts that are being used today—from GDP to the natural rate of growth—were developed during the 1930s and 1940s in the context of mass production, the war effort and the development of the national welfare state.
According to the dogmas of the current orthodoxy, the credit crunch should not have happened, quantitative easing should have led to inflation and increasingly unfettered markets (without any ‘crowding out’ from the government) should have already achieved strong growth. Their recommended austerity policies have now gone on for eight years with feeble to appalling results; any CEO of a serious corporation with an equivalent failure rate would have been replaced years ago.

In fact, as I will suggest below,
neoliberalism may require sacrifice as a supplement, something outside of its terms, yet essential to its operation.20
While, in the transition from liberal to neoliberal democracy, citizen virtue is reworked as responsibilized entrepreneurialism and
self-investment, it is also reworked in the austerity era as the “shared
sacrifice” routinely solicited by heads of state and heads of businesses. 21
Such sacrifice may entail sudden job losses, furloughs, or cuts in pay,
benefits, and pensions, or it may involve suffering the more sustained
effects of stagf lation, currency def lation, credit crunches, liquidity
210 u n d o in g t h e d e m o s
crises, foreclosure crises, and more.22 “Shared sacrifice” may refer
to the effects of curtailed state investment in education, infrastructure, public transportation, public parks, or public services, or it may
simply be a way of introducing job “sharing,” that is, reduced hours
and pay. Regardless, as active citizenship is slimmed to tending oneself as responsibilized human capital, sacrificial citizenship expands
to include anything related to the requirements and imperatives of
the economy.23
This slimming of active citizenship and the expansion of citizen sacrifice are facilitated through the neoliberal supplanting of
democratic political values and discourse with governance, the consensus model of conduct integrating everyone and everything into
a given project with given ends.

…

In all cases, however, its consummate sign is the willingness
to risk life, which is why soldiers in battle remain its enduring icon
and why Socrates rendered acceptance of his death sentence as ultimate proof of his loyalty to Athens and compared himself to a soldier when doing so.41 Today, as economic metrics have saturated the
state and the national purpose, the neoliberal citizen need not stoically risk death on the battlefield, only bear up uncomplainingly in
the face of unemployment, underemployment, or employment unto
death. The properly interpellated neoliberal citizen makes no claims
for protection against capitalism’s suddenly burst bubbles, job-shedding recessions, credit crunches, and housing market collapses, its
appetites for outsourcing or the discovery of pleasure and profit in betting against itself or betting on catastrophe. This citizen also accepts
218 u n d o in g t h e d e m o s
neoliberalism’s intensification of inequalities as basic to capitalism’s
health — comprising the subpoverty wages of the many and the bloated
compensation of bankers, CEOs, and even managers of public institutions and comprising as well reduced access of the poor and middle
class to formerly public goods, now privatized.

For the financial industry,
they mostly make for grim reading. Gallup, for example, has asked
Americans on a regular basis since the end of the 1970s about their
confidence in banks.2 The percentage of respondents answering
positively – ranging between ‘quite a lot’ and ‘a great deal’ – stood at
60 per cent in 1979 and fell to a low of 30 per cent in the early 1990s
during the first (and, it now seems, minor) credit crunch before
rebounding to 53 per cent in 2004. At its nadir in late 2010, however,
only 18 per cent responded positively. Meanwhile, although generally sceptical about the legislative programme in Congress, American
citizens have been unusually supportive of one particular area of
legislation, namely ‘increased government regulation of banks and
major financial institutions’. If politicians and regulators want to
absolve themselves of blame for their own part in the financial crisis,
they know where to turn.

…

This will take place under a number of different guises. Those
creditors wary of getting their money back will be tempted to keep
their savings at home. Money that might otherwise have gone into
growth-­enhancing foreign ventures may, instead, be kept under the
proverbial mattress: safety will trump risk. Global imbalances will
narrow, but only because foreign investors will no longer be prepared
to fund the borrowing of others: the credit crunch will thus become
a cross-­border event. Those who want to borrow will increasingly
have to go in search of funds generated domestically. In the event of
a funding shortage, financial institutions will be increasingly compromised: unable to raise funds internationally on the scale seen pre-­
financial crisis, they will nevertheless be under pressure to lend
domestically and, often, to projects that may seem to be politically
expedient if not economically or financially worthwhile.

pages: 346words: 90,371

Rethinking the Economics of Land and Housing
by
Josh Ryan-Collins,
Toby Lloyd,
Laurie Macfarlane,
John Muellbauer

The severity of this decline in affordability was masked, for a while at least, by low mortgage rates, which kept monthly repayments within reasonable bounds for those buyers able to find sufficient capital for a deposit (Wilcox, 2006). Policy responses to the mounting affordability pressure therefore focused on helping first-time buyers over the deposit barrier through a series of low-cost homeownership initiatives, while the market response was to offer mortgages on ever higher loan-to-value rates – peaking at over 100% in some cases. The credit crunch and subsequent monetary easing reinforced this picture of high house prices and low mortgage rates, while the withdrawal of high loan-to-value mortgages raised the deposit barrier ever higher. As affordability pressures worsened and first-time buyer rates plummeted government resorted to ever more generous subsidies for marginal homeowners (Wilson and Blow, 2013).
Figure 4.3 Ratio of house prices to gross average earnings (source: Bank of England, 2016d; DCLG, 2010)
As we discuss in Chapters 5 and 6, the consequence of the long house price boom was a huge increase in both the asset wealth of homeowners and the amount of mortgage debt outstanding.

…

Of the top ten mortgage lenders in 2007 (which represented 78% of the market), those with the highest reliance on RMBS (and representing a third of the market) had all been bankrupted, nationalised or taken over by autumn 2008 (Ball, 2009, p. 128).
This was seen spectacularly in the announcement of the sale of Halifax Bank of Scotland (HBOS) – by far the country’s largest mortgage lender with a fifth of the market prior to the credit crunch – to Lloyds TSB in September 2008. Around the same time, the Bradford and Bingley was broken up between Banco Santander of Spain and the UK government. Santander also took over Alliance and Leicester, while over the course of the previous year several specialist lenders had ceased to provide new mortgages (Ball, 2009, p. 121).
Mortgage financing collapsed. There were 24,300 loans for house purchase in February 2009, 47% down on a year earlier, according to the Council of Mortgage Lenders (Lambert, 2009).

pages: 293words: 88,490

The End of Theory: Financial Crises, the Failure of Economics, and the Sweep of Human Interaction
by
Richard Bookstaber

Amateur Hour
A leaked internal memo written by Carlyle’s William Conway dated January 31, 2007 showed that that the boom was almost over: “most investors in most assets classes are not being paid for the risks being taken...the longer it lasts the worst it will be when it ends...if the excess liquidity ended tomorrow I would want as much flexibility as possible.”14 Shortly after the Blackstone IPO, U.S. subprime problems overflowed into a general credit crunch, and the debt markets ground to a halt. As the global recession affected earnings and cash flows, companies that had been leveraged up in buyouts found it difficult to meet debt repayments. Drops in stock prices reduced values, making it difficult to offload businesses.
By July 2007, EMI was in difficulties. With CitiGroup unable to sell off the debt that it had underwritten, Terra Firma and the bank considered abandoning the deal.

…

The problem is that a large part of the profits are not actually cash, but unrealized paper gains based on sometimes dubious market values for illiquid instruments and even more dubious models. The deadly pathology of finance—the gaming of bonus systems, manipulation of valuations, and accounting tricks—continues. As one observer notes: “It is simply amazing to me how much money you can make by shuffling papers. We have come a long way from our industrial giants.”25
In New York, credit-crunch tours take in the original Lehman Brothers building and New York’s Federal Reserve. In Bowling Green Park, downtown Manhattan, visitors still pose to have their photos taken near Arturo di Modica’s statue of a charging bull. Guides show tourists a real toxic asset—a thick prospectus for a 2006 $1.5-billion subprime CDO that was rated AAA where investors lost almost all their investment. The guide explains that the $185 billion of the taxpayer bailout would fill an entire alley near the AIG building to a height of nearly 7 feet (2 metres).

…

Michael Hirsh (2010) Capital Offense: How Washington’s Wise Men Turned America’s Future Over to Wall Street, John Wiley, New Jersey.
Karen Ho (2009) Liquidated: An Ethnography of Wall Street, Duke University Press, Durham and London.
Marina Hyde (2009) Celebrity: How Entertainers Took Over the World and Why We Need an Exit Strategy, Harvill Secker, London.
William Isaac (2010) Senseless Panic: How Washington Failed America, John Wiley, New Jersey.
Tetsuya Ishikawa (2009) How I Caused the Credit Crunch: An Insider’s Story of the Financial Meltdown, Icon Books, London.
Michael Jensen (1976) The Financiers: The World of the Great Wall Street Investment Banking House, Weyright and Talley, New York.
Simon Johnson and James Kwak (2010) 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, Pantheon Books, New York.
Asgeir Jonsson (2009) Why Iceland: How One of The World’s Smallest Countries Became The Meltdown’s Biggest Casualty, McGraw Hill, New York.

You should view the segment for yourself to gain an impression of the smug demeanor of someone who has drunk the Kool-Aid a little too avidly. I had to check my browser to make sure I wasn’t watching a clip from The Colbert Report. Perhaps Cochrane and I had been living in parallel universes over the previous two years. Just one representative quote: “The economy can recover very quickly from a credit crunch if left on its own.” Maybe in the Chicago Wormhole Universe.30
But then again, maybe not. The New Statesman had the brilliant idea of reconnecting with the twenty U.K. economists who had signed an open letter in February 14, 2010, supporting Chancellor George Osborne’s strategy of producing growth through fiscal austerity and budget cuts.31 Since then, Britain had promptly entered further contraction, and the Treasury ended up far exceeding its borrowing limits: so much for deficit reduction.

(This generalization would also have to take into account the subsequent popularity of a few serial Cassandras such as Nouriel Roubini and Marxists such as David Harvey and Robert Brenner: they exist outside the ambit of this book, dealing as it does with the orthodox neoclassical profession.)
36 Buiter, “The Unfortunate Uselessness of Most State of the Art Academic Monetary Economics.” Buiter then wrote: “The Bank of England in 2007 faced the onset of the credit crunch with too much Robert Lucas, Michael Woodford and Robert Merton in its intellectual cupboard. A drastic but chaotic re-education took place and is continuing.” Chapter 5 reveals that, in this instance, another economist’s prediction has since bitten the dust.
37 Ibanez, The Current State of Macroeconomics, p. 180.
38 Blanchard, “The State of Macro.”
39 They are available online at www.newyorker.com/online/blogs/johncassidy/chicago-interviews.

Even though we lowered the fed funds rate no fewer than twentythree times in the three-year period between July 1989 and July 1992, the
recovery was one of the most sluggish on record. "The U.S. economy is best
described as moving forward, but in the teeth of a fifty-mile-an-hour headwind" was how I explained the situation to an audience of worried New
England businessmen in October 1991.1 couldn't be very encouraging, because I didn't know when the credit crunch would end.
I
would see President Bush every six or seven weeks, usually in the con-
text of a meeting with others but sometimes one-on-one. We had known
each other since the Ford years. He'd even had me over to Langley for
lunch when he was director of Central Intelligence in 1976. During the
early months of the 1980 campaign, he often called me on economic policy
issues. While Bush was vice president, I would join him every so often at
the White House.

…

I'd made
that argument at the start of Bush's term, and now the problem was four
years worse. The national debt held by the public had risen to $3 trillion,
causing interest payments to become the third-largest federal expense after
Social Security and defense. So when Clinton asked for my economic assessment, I was ready with a pitch.
Short-term interest rates were rock-bottom low—we'd cut them to 3
percent—and the economy was gradually shaking off the effects of the
credit crunch and growing at a fairly reasonable pace, I told him. More than
a million net new jobs had been created since the beginning of 1991. But
long-term interest rates were still stubbornly high. They were acting as a
brake on economic activity by driving up the costs of home mortgages and
143
More ebooks visit: http://www.ccebook.cn ccebook-orginal english ebooks
This file was collected by ccebook.cn form the internet, the author keeps the copyright.

…

By the end of 1993, not only had
real GDP grown 8.5 percent since the 1991 recession, but it was expanding
at a 5.5 percent annual rate.
All of which led the Fed to decide that it was time to tighten. On February 4, 1994, the FOMC voted to hike the fed funds interest rate by onequarter of a percentage point, to 3.25 percent. This was the first rate hike
in five years, and we imposed it for two reasons. First, the post-1980s credit
crunch had finally ended—consumers were getting the mortgages they
needed and businesses were getting loans. For many months, while credit
was tight, we'd kept the fed funds rate exceptionally low, at 3 percent. (In
fact, if you allowed for inflation, which was also nearly at a 3 percent annual rate, the rate on fed funds was next to nothing in real terms.) Now that
the financial system had recovered, it was time to end this "overly accommodative stance," as we called it.

This itself is an expensive problem, which is most easily solved by bringing in new working-age immigrants whose taxes can cover spiraling state expenses. Alternatively, governments can raise taxes, cut services, or raise retirement ages, but, without immigration, the standards of living will decrease and governments will be unable to afford crucial services and policies.† As it is, the fiscal cost of paying for the credit-crunch bailouts of 2008 and 2009 is expected to consume between 2 and 4 percent of the GDP in Britain and the United States for more than a decade. So, while immigration is not a mandatory solution to labor shortages, the combination of cash-starved governments and higher demographic costs will make it the least painful and most voter-friendly solution.
According to a 2009 study by the University of Southern California’s Marshall School of Business, the United States will require 35 million more workers than its working-age population can provide by 2030, Japan another 17 million by 2050, the European Union 80 million by 2050.

…

This has given considerable economic and social power to women in many otherwise traditional communities; it has also, in turn, made child-care services a desperately important commodity in the arrival city.
Even with all those income sources, it was not a simple matter of buying a house. The Parabs were not eligible for any kind of actual mortgage. India’s banks are extremely conservative in their lending practices, a fact that saved the country’s economy from ruin in the credit-crunch crisis of 2008 but that also has frozen millions of people out of the housing market. Instead, as millions of other families in the developing world do, they took out a consumer-purchase loan, ostensibly for buying appliances and at a far higher interest rate than most mortgages. Even that was not quite enough: As is customary in Mumbai, off the books they had to pay several thousand dollars in “black money” cash payments directly to the sellers, above and beyond the official purchase price.

“The Lin story has broken out into the general culture” David Carr, “Media Hype for Lin Stumbles on Race,” New York Times, February 19, 2012.
CHAPTER 4: RESPONDING TO REVOLUTION
“A lesson from the technology industry” Reid Hoffman and Ben Casnocha, The Start-Up of You: Adapt to the Future, Invest in Yourself, and Transform Your Career (Crown Business, 2012), p. 71.
Eight days later, George Soros hosted twenty Chrystia Freeland, “The Credit Crunch According to Soros,” Financial Times, January 30, 2009. Unless otherwise specified, all quotes in this section originally appeared in this piece.
an average of 31 percent Charles Morris. The Sages. p. 3.
According to a study by LCH Investments Rick Sopher, “Great Money Managers,” self-published by LCH Investments, November 2011. After retiring in 2010, Soros was overtaken the following year by Bridgewater’s Ray Dalio.

…

“I’ve been through probably six crises” CF interview with Peter Weinberg, June 25, 2009.
the ability to “pivot” Caroline O’Connor and Perry Klebahn, “The Strategic Pivot: Rules for Entrepreneurs and Other Innovators,” Harvard Business Review blog network, February 28, 2011.
Flickr’s genesis was in 2002 See Jessica Livingston, Founders at Work: Stories of Startups’ Early Days (Apress, 2007), pp. 257–264.
“One thing that I’ve both wrestled with” Chrystia Freeland, “The Credit Crunch According to Soros,” Financial Times, January 30, 2009.
“My conceptual framework, which basically emphasizes” CF interview with George Soros, December 16, 2008.
“It’s an almost aggressive pessimism about his own ideas” CF interview with Jonathan Soros, July 14, 2009.
“The businesses and institutions underpinning” Jennings, “Opportunities of a Lifetime.”
“The group of winners is churning at an increasing and rapid rate” “Measuring the Forces of Long-Term Change: The 2009 shift index”, Deloitte Center for the Edge, December 2009, p. 115.

As its “auto czar,” the Obama administration picked Steven Rattner, the founder of the private equity firm Quadrangle Group, and to help oversee the turnaround of General Motors Corporation, it named David Bonderman, the founder of Texas Pacific Group, and Daniel Akerson, a top executive of Carlyle Group, to the carmaker’s board of directors.
The crisis of 2007 to 2009 wasn’t the first for private equity. The buyout industry suffered a near-death experience in a similar credit crunch at the end of the 1980s and was wounded again when the technology and telecommunications bubble burst in the early 2000s. Each time, however, it rebounded and the surviving firms emerged larger, taking in more money and targeting new kinds of investments.
Coming out of the 2008–9 crisis, the groundwork was in place for another revival. For starters, the industry was sitting on a half-trillion dollars of capital waiting to be invested—a sum not so far short of the $787 billion U.S. government stimulus package of 2009.

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By mid-August, the spread was nearly 4.6 points, as demand for CLOs evaporated and investors balked at buying debt of highly leveraged companies, particularly when there were few covenants on the loans and bonds and the borrowers could opt to pay interest on bonds by issuing more paper. It was eerily familiar to veterans of the buyout world who had lived through 1989. Risk, which had been virtually banished from the financial lexicon, had returned to the discussion, and now the term “credit crunch” was being bandied about.
There was no single event that triggered the shift, as there had been in 1989, when the collapse of the financing for the employee buyout of United Airlines sent the debt markets tumbling, but the pivot in 2007 was nearly as swift, and just as disastrous for private equity’s investment banks as it had been in 1989. As underwriters and loan arrangers, the banks had issued legally binding promises to provide loans to finance dozens of still-to-be-completed LBOs and had assumed the risk of peddling that debt to others.

There has been a small avalanche of books on the financial crisis of 2007, some of them illuminating, many merely providing superficial narratives of successive financial disasters and the key players in them, served up with journalistic brio. Some critiques have targeted the hubris of the financial sector, identifying mismanagement, poor judgement and questionable legality. But some have seen the credit crunch and recession as evidence of something more basic – capitalism’s crisis-prone nature.
Why We Can’t Afford the Rich isn’t just about the financial crisis, dire though it is. It’s about what underpins and generates such crises – the very architecture of our economy. It treats the economy not merely as a machine that sometimes breaks down, but as a complex set of relationships between people, increasingly stretched around the world, in which they act as producers of goods and services, investors, recipients of various kinds of income and as taxpayers and consumers.

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Countries that become dependent on borrowing on the bond markets – mostly from large domestic and foreign banks, pension funds and insurance companies – can find themselves in a vulnerable position if they do not meet bondholders’ preferences regarding economic management, let alone if they are at risk of defaulting. For example, in 1993 in the US when the Clinton administration introduced new legislation to greatly expand healthcare without properly funding it (‘HillaryCare’), long-term interest rates began to rise. The 10-year rate on US Treasury bonds touched 8% in 1994. The consequent threat of a credit crunch in the business sector, and higher mortgage rates for prospective home buyers, generated enough political opposition to stop it going through Congress.65 Bondholders – sometimes dramatised as ‘bond market vigilantes’ – can simply bid up interest rates or refuse to lend anew. As James Carville, lead strategist for US President Bill Clinton famously commented, ‘I used to think that if there was reincarnation, I wanted to come back as the President or the Pope.

The deal was poisoned, though, by Yahoo, which had cooked up a series of internal forecasts suggesting that the company would grow much bigger and be worth far more than a measly $45 billion. The forecasts were wildly wrong, predicated on levels of advertising growth that required the future to be just like the previous six years – only more so. Yahoo’s executives, led by Jerry Yang, made the wrong call once again. This time, Yahoo failed to perceive that it was at the tail end of an enormous financial bubble, and repeatedly rejected Ballmer. When the credit crunch hit in the summer, big advertisers drastically cut back their marketing budgets, and Yahoo was suddenly left scrabbling for revenue. The bid collapsed, Yang was forced out, and in January 2009 Carol Bartz, a tough-talking Silicon Valley veteran, was offered the helm of Yahoo. She was more receptive to a simpler offer from Microsoft: that it would power Yahoo search and help serve advertisements.

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In July 2008 Apple launched the iPhone 3G, cutting its prices in half while also adding 3G connectivity (and so faster data access) and GPS capability. The aim – to capture market share – worked: from July 2008 to June 2009 – the period covering the arrival of the 3GS and apps on the iTunes App Store – iPhone sales quadrupled to 20.25 million compared to the same 2007/08 period, while the smartphone market grew by less than 20 per cent (and, amid the credit crunch, the overall mobile market actually shrank). By July 2009, the 65,000 apps had had 1.5 billion downloads. The investment in building the iTunes Music Store all those years ago was clearly paying off; apps downloads were running at the same rate as song downloads and, while there were many more sources to deal with, as well as the extra work for Apple of approving apps to be published (a non-trivial task for which it employed around 40 people working full time), they brought clear benefits.

But such lending is unattractive to banks today because the interbank lending rate is zero due to Fed intervention. Since banks cannot earn a market return on such interbank lending, they don’t participate in that market. As a result, liquidity in the interbank lending market is low, and banks can no longer be confident that they can obtain funds when needed. Banks are therefore reluctant to expand their SME loan portfolios because of uncertain funding.
The resulting credit crunch for SMEs is one reason unemployment remains stubbornly high. Big businesses such as Apple and IBM do not need banks to fund growth; they have no problem funding activities from internal cash resources or the bond markets. But big business does not create new jobs; the job creation comes largely from small business. So when the Fed distorts the interbank lending market by keeping rates too low, it deprives small business of working capital loans and hurts their ability to fund job creation.

In an attempt to keep things flowing, the Fed expanded the type of assets it would accept as collateral from distressed banks, reduced penalty rates to virtually nothing, and speeded up auctions of quality bonds, so banks could put those on their balance sheets and off-load the junk onto the Fed. But there was still no stampede to the discount window.
Buyers of securities had disappeared; the great derivatives locomotive had slammed on the brakes, causing the train cars behind to slam into one another, derail, and slide off the mountain.
In mid-April 2008, the IMF warned that potential losses from the credit crunch foreshadowed by Bear’s fall could surpass $1 trillion. As if on cue, Swiss bank UBS reported an $11.5 billion loss and announced that it would cut 5,500 jobs by the middle of 2009.
The bond issuers were the next to get hit. On May 13, MBIA, the world’s largest bond insurer, reported $2.4 billion in losses due to write-downs of CDSs. By early June, Moody’s announced it would probably downgrade MBIA and the second-largest player, Ambac.